Those that read my previous 2 posts (the many of you!), probably recall my ramblings about the emotional shortcomings that threaten to undermine our investing endeavours. As humans we do not exhibit the completely rational behaviour that is often assumed by economists in building their elegant theorems. Quite the contrary, you and I surely tend to over-react to most extreme events on both the positive and negative scales, to favour the known, to rejoice in our pre-conceived ideas and to base most of our assumptions and forecasts on the most recent of experiences.
To make things more difficult (as if we needed to...), it seems that for those of us that have had the "benefit" of a formal education in business, undergraduate, MBA or any other similar format, the concepts learned may have actually done us a disservice!. Sounds strange huh?. Surely isn't the investing hall of fame full of hot-shot MBAs and the like?.
Perhaps so, but the truth remains that fortunes built in this sector of activity owe little to the application of sophisticated and elegant-sounding techniques and concepts like the ever-present Capital Asset Pricing Model (CAPM) or its even more esoteric "beta" offspring. For those of you that have not had the fortune (or should I say misfortune!) of coming across the term "beta", let me just say that it is a statistical measure used in modern finance theory used to measure risk. So far so good, I hear some say. But wait for the best part; beta measures risk in terms of "volatility" or put in simpler terms, variation in return versus an average.
In other words, an investing asset that trades with high volatility, no matter if that variation is on the downside, (that is it becomes cheaper to acquire), is deemed to be of higher risk!. This makes no sense at all. Just think of it this way: imagine you wish to buy a nice leather jacket that you see in a shop window but for which the price today is 300 €. You come back next week to the same shop and it is offered at a 40% discount, that is, it sells for 180 €. Should you buy it?. I say YES but most professional investors using beta as a measure of risk would call this asset (substitute for "leather jacket") risky and walk away.
With "priceless" lessons like this and other gems like the ever-efficient nature of the stock market championed by proponents of Efficient Market Theory (EMT) which, by the way, last I heard still ruled the best business schools, it's no wonder even bright minds falter at this game.
But on a positive note, I'd like to leave you with a different interpretation of this state of affairs so as to rebuke my initially somber stance:
Just think for a moment that if your "competitors" (and indeed everyone else in investing is a direct competitor given the zero-sum game nature of the market) have read the same EMT-preaching authors, they will feel that nothing can be gained form trying to get an edge and as such will allow you to play against those who believe that it is simply not worth trying!.
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