Diamondjag Legend  Posts: 404 Joined: 3/12/2006 Location: Brighton, Colorado  User Profile | Here something that struck me while reading the book “Thinking Fast and Slow” by Nobel Prize winning psychologist Daniel Kahneman. A little sobering but I hope of some use as you are ready to start a new year of trading. The quotes are summarized in the last sentence: that we all are overconfident about our ability to predict the future. We have an illusion of skill and an illusion of validity (illusion that what we think we know is true). “ my questions about the stock market have hardened into a larger puzzle: a major industry appears to be built largely on an illusion of skill.” “…the first demonstration of this startling conclusion was collected by Terry Odean, a finance professor at UC Berkley. Odean began by studying records of 10,000 brokerage accounts of individual investors spanning a seven year period. He was able to analyze every transaction the investor executed through that firm, nearly 163,000 trades. By these actions the investor revealed that he had a definite idea about the future of the stocks, he expected the stock that he chose to buy to do better than the stock he chose to sell. The results were unequivocally bad. On average, the shares that individual traders sold did better than those they bought by a very substantial margin. “ “Bard Barber wrote a paper titled “Trading is Hazardous to Your Wealth”. It showed that, on average, the most active traders had the poorest results, while the investors who traded the least earned the highest returns.” “Evidence from more than fifty years of research is conclusive: for a large majority of fund managers, the selection of stocks is more like rolling dice than like playing poker. Typically, at least two of every three mutual funds do not achieve their own benchmark in any given year. The successful funds in any given year are mostly lucky, they have a good roll of the dice. There is a general agreement among researchers that nearly all stock pickers, whether they know it or not, and few of them do, are playing a game of chance.” “I asked for some data to prepare my presentation and was granted a small treasure: a spreadsheet summarizing the investment outcome of some twenty five anonymous wealth advisers, for each of eight consecutive years. I knew the theory and was prepared to find weak evidence of persistence of skill. Still, I was surprised to find that the average of the 28 correlations was .01. In other words, zero. The consistent correlations that would indicate differences in skill were not to be found. The results resembled what you would expect from a dice-rolling contest, not a game of skill.” “Why do investors, both amateur and professional, stubbornly believe that they can do better than the market? The explanation of the prevalence and persistence of an illusion of skill in the financial world. The most potent psychological cause of the illusion is certainly that the people who pick stocks are exercising high-level skills.” “Unfortunately, skill in evaluating the business prospects of a firm is not sufficient for successful stock trading, where the key question is whether the information about the firm is already incorporated in the price of its stocks. Traders apparently lack the skill to answer this crucial question, but they appear to be ignorant of their ignorance.” “As Nassin Taleb pointed out in “The Black Swan", our tendency to construct and believe coherent narratives of the past makes it difficult for us to accept the limits of our forecasting ability. Everything makes sense in hindsight. The illusion that we understand the past fosters overconfidence in our ability to predict the future. “ “The main point of this chapter is not that people who attempt to predict the future make many errors, that goes without saying. The first lesson is that errors of prediction are inevitable because the world is unpredictable. The second is that high subjective confidence is not to be trusted as an indicator of accuracy.” Dave [Edited by Diamondjag on 12/16/2017 8:18 PM] | |
