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Markets 101 Michel Pireu     | Business Day Tuesday, November 27, 2018
Wall Street wisdom, such as it is, largely revolves around a few eternal quandaries. And because they are never settled in one direction or the other, investment pundits thrive by dispensing conspicuously contradictory advice. According to some, for example, investors should cut their losses and allow their profits to run. While from others comes the warning that the greedy quickly become the needy. Or the maxim that, “Bulls make money, bears make money, pigs get slaughtered.” So which is it? Should investors resist the urge to cash in while they’re ahead or should they take the money and run?

When all’s said and done, there’s no right answer – both approaches can just as easily produce the right or wrong outcome innumerable times.

The problem with stock market truisms, what eventually makes them untrue, is that while they might apply to some, even most, situations, they won’t always apply to all situations. At some point they turn out to be poor counsel. When it comes to the stock market, contradictions can seemingly be found in everything.

This, by itself, isn’t necessarily a problem though. The problem is created by black and white thinking – from taking a too simplistic approach to the complexity of investing. When context matters, it’s important to respect the grey zone. To acknowledge that within the vast array of different investment options, opposite approaches can succeed – provided they’re made of the right stuff. What’s the right stuff? As Farnam Street put it, “The stuff you should have learned in the ‘101’ course of each major subject - the true general principles that underlie most of what's going on.”

So, what true general principles should we have learned in our 101 course on the markets?

For a start, that markets are smart. Financial markets may not be as efficient as some academics want to believe. Not perfectly so. But they are undoubtedly collectively smarter than any individual and certainly smart enough to eliminate any low-hanging fruit. That’s not to say no one can outperform the markets; there are outliers that can beat the market averages. However, there are many more outliers that lose big to the markets. The majority of investors are not to be found somewhere in the middle, but on the losing side. On-going successes are few and far between. And, whilst it’s not a popular theory, even household names like Peter Lynch and Warren Buffett, whilst financial whizzes, may also have been exceptionally lucky.

Markets are a complex game. As Nassim Taleb says, "If you roll dice, you know that the odds are one in six that the dice will come up on a particular side. So you can calculate the risk. But, in the stock market, such computations are bull - you don't even know how many sides the dice have!"

Emotions run the game. As Barnie Winkleman wrote in his book, Ten Years of Wall Street, “The golden mean is non-existent in Wall Street, because the speculative mechanism does all things to excess; even the reactions from the heights of fantasy and from the depths of despair are accompanied by convulsions which are distinct from the calmer tenor of business. Those who seek to relate stock movements to the current statistics of business, or who ignore the strongly imaginative taint of stock operations, or who overlook the technical basis of advances and declines, must meet with disaster, because their judgment is based upon the humdrum dimensions of facts and figures in a game which is played in a third dimension of the emotions, and fourth dimension of dreams.”

It’s not a fair game. Lip service is often paid to enforcing a “fair” market, where all can trade on a level playing field, but everybody knows that institutional investors are treated differently, more favourably; with huge resources and access to massive amounts of data on top of high-level access to executives. Even when the same information is released simultaneously - a rare event - to all market participants, the HFT algobots will have acted on it long before any individual investor has had time to read the headline. If you feel you can go up against them, power to you — just don’t expect a fair fight.

Everyone’s in it for themselves. If those who make a living selling newsletters, trading systems, mentoring, coaching, blogging, writing the news or appearing on television tell you they believe the markets (or a stock) are going to do this or that, why would you want to believe them? You can be sure they have a reason, other than your good interest at heart, to share anything with you.

As Carl Icahn says, “You learn in this business: If you want a friend, get a dog.”

Marketscall for a different mind-set. “Extraordinary performance comes from being different,” says Howard Marks. “It must be that way. Of course, below average performance comes from being different too — on the downside. Neither is it enough to be different — you also need to be correct. The goal is not blind divergence but rather a way of thinking that sets you apart from others. A way of thinking that gives you an advantage.”

“I sometimes think that speculation must be an unnatural sort of business,” Jesse Livermore tells Edwin Lefèvre in Reminiscences of a Stock Operator. “Because the weaknesses that all men are prone to are fatal to success in speculation… in speculation when the market goes against you, you hope that every day will be the last day – and you lose more than you should had you not listened to hope – to the same ally that is so potent a success-bringer to empire builders and pioneers. And when the market goes your way you become fearful that the next day it will take away your profit, and so you get out-too soon. Fear keeps you from making as much money as you ought to. The successful trader instead of hoping must fear; instead of fearing must hope. He must fear that his loss may develop into a much bigger loss, and hope that his profit may become a big profit.”

Markets may be an impossible dream. "For an individual investor, the notion of being able to trade stocks successfully is just generally pure folly,” claims Richard Bernstein. “You'd think that people would realize that.” Can you get rich trading the markets? Probably not. Getting rich in the market is only possible to the same extent that it’s possible for you to become a Pro golfer, a Champions League soccer player or an astronaut. In other words, a few special people will, but you statistically won't. “There isn’t a man on Wall Street who has not lost money trying to make the market pay for an automobile or a bracelet or a motorboat or a painting,” says Jesse Livermore. “In fact of all the hoodoos on Wall Street I think the resolve to induce the stock market to act as fairy godmother is the busiest and most persistent.”
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