Whenever I think of the stock market and investment, I am reminded of my days as a GCSE business student. We had a competition where we each had to choose companies on the FTSE100 to invest in. Whoever made the best return on their investment was the winner. With it being winter at the time, I decided to invest in gas companies- my logic being that it was cold so people would spend more money on heating. Needless to say, I didn’t win. Instead the winner was a student that (to put it politely) was a bit dense. When our teacher asked him how he had decided to invest, he replied “I just picked the ones I liked the names of”.
It’s quite amusing to see that there are plenty of examples similar to this. To hear that monkeys and playmates have succeeded in embarrassing the ‘experts’ of the investment world does raise the question as to whether there is any way to accurately predict the performance of individual companies, or the market as a whole.
If you were to consider Kendal’s idea of ‘Random Walks’, it would suggest that even trying to predict share price movements is difficult, if not impossible. With there being an estimated (2002 figures) $60 trillion traded daily on global financial markets, for investors to accept this and allow their money to be left in the hands of luck would be suicidal.
Fama has a sensible take on stock market efficiencies- that market efficiency can be defined as weak or semi strong depending on the reaction to new information. Looking at the recent example of Shell, they saw their share price fall from 2,268 at the start of trading on February 3rd to 2,155 at the close of trading that very same day, purely from the fact that they released details of their annual profits. This instant and fairly significant reaction to new information is evidence of the London Stock Exchange being a semi-strong form when it comes to market efficiency.
The most surprising thing about Shell’s share price falling 3% in one day is that they actually reported a rise from $9.8bn to $18.6bn. This is an anticipatory approach was taken towards Shell that hasn’t quite worked out. Not quite the perfect market efficiency that is strived for, but in the real world, and considering the nature of our race, perfect efficiency could never happen.
In the Turner Report, one of the key criticisms of stock market pricing is individual behaviour is not entirely rational. People tend to allow themselves to be ruled by their emotions which will not always be the rational decision to make. In the case of Shell, this could quite possibly explain the over-anticipated profit levels. Over the past year however, we are assured by Richard Hunter, head of equities at Hargreaves Lansdown Stockbrokers that shares have in fact risen by 27%. Looking at the long term, it can be seen that it is usually the case that good performance is rewarded with a good share price.
With the level of uncertainty in returns, can the stock market be seen as anything more than speculative gambling? From a short term perspective, it certainly seems like a daunting prospect. When you start to look at the bigger picture however, it becomes evident that the stock market can provide returns that would dwarf any savings account you will ever find. Looking at the graph in this link, you can see that even after an economic crisis, the performance of the FTSE 100 over the past 23 years is impressive.
On http://www.coolinvesting.com/, there is a great quote that answers the question, ‘why invest?’.
“It really is nearly a rhetorical question. Investing is the best way to secure your future. In this world there are two ways to earn income; one is to exchange you labor for dollars and the other is to have your money earn money for you. The rich know this and the poor don’t. It’s as simple as that.”
With that in mind, and looking at the long term performance of stock markets, these pension and insurance funds seem to be invested in the most sensible place possible. Forget roulette wheels, poker, accumulators or anything else- the stock market is the smart way to gamble!
Hey Jonny, I like your take on the stock market being one of the safer gambling mediums of today!
ReplyDeleteThe portrayal of an entirely random stock exchange is definately something to be feared, if I had large sums of money to invest luck wouldn't be something I'd bet on.
At the same time do you not think the reason for thinking it to be a random game is because of the unpredictablility of 'new information', I would never say the share price movements are random, but they definately represent a massive collection of differing personal perspectives of where the company is going.
Of course i could go on to say the actions of a company are random in the sense of the unpredictable actions of a CEO could be totally random to my understanding. Would you say in some instances random and unpredictable could be classed as the same?
On one hand, to predict the share price is difficult because they follow a 'randon walk' and their are different investors with different invest attitude. that is to say, the stock market is like a speculative gambling place. On the other hand, I think, there are also some potiencial rules we can follow.
ReplyDeleteThere are a few people that can be very successful in the stock market. Why they can so successful? Is that they are inside trader, or anything else?
Obviously insider traders that have been caught have been known to have privileged information and that's how they have abnormally benefited from the stock market. But i agree with what Kelly has to say... If the stock market is seen to be semi strong efficient and prices reflect new information, people do not know what this information is going to be therefore cannot predict the market. Leaked information can change this but then again how reliabled would that be?
ReplyDeleteI agree with you there Kelly, share prices are undoubtedly massively affected by the disclosure of new information.
ReplyDeletePerhaps I put too much emphasis on just how random stock market prices are, it is more the reaction to information that is the problem. I think to say that the decisions of a company (and the information that is disclosed as a result of this) are random would be inaccurate. When looking statistically, share prices probably can be interoperated as random. I guess that could be a result of the stock market overreacting as opposed to the CEO, or anyone else involved in the direction of the business making random decisions.
So in answer to your question, I think in the stock market, nothing is truly random. More the reactions of people allowing themselves to be ruled by emotion rather than logic can make share prices appear to be random.
Elim, I think it would be naive for me to say that inside traders do not exist, because it is evident that they do. The success that people experience in the stock market can’t be attributed just to this though. As I demonstrated with the graph regarding the performance of the FTSE100 over the past 23 years, a lot of people benefit from the stock market just by spreading risk.
I agree to the idea that people are ruled by emotions and therefore pricing decisions reflected in the stock market may often seem irrational. In the case of Shell though I'd like to think the reaction was very much rational as well as driven by emotions - people were expecting higher profit figures to be reported and therefore decreased share price potential y reflects their unfulfilled expectations and perhaps their worries about the business health.
ReplyDeleteAnd yes, if you are not an inside trader and just a regular trader, you cannot predict the future information and therefore the movements of the share price in the market, which could leave you making the decisions driven by your emotions and hopes, well at least mine anyway...