Anonymous blogger Zero Hedge is getting his 15-minutes. Big time.
“Tyler” was on Bloomberg on Monday discussing “trading” done by Goldman Sachs:
I have said many times before that focus on very small time frames is often counterproductive because of a host of issues, including slippage and commission. And now you know that you are also competing with GS on the 1-minute or 233-tick chart. Remember, their algorithms are not “trading” per se. They are essentially making the market, matching buys and sells for a handsome profit.
Now that the market been rising for a few months, we have probably entered a phase where a lot of lucky people will conclude that they are smart. At this point, traders are probably going wild with small-caps, penny dreadfuls or deep out-of-the-money calls, but wait, is it a good idea to bet on black swans? This dangerous illusion is exposed in Eric Falkenstein’s book.
In my book Finding Alpha, I argue that people tend to pay for hope, and nothing offers hope better than the lottery-like returns available in potential Black Swans. Hope is a good thing, and motivates a lot of hard work and creativity. But it would be foolish to think that the more improbable, the more speculative, the more derided by economists, the better the risk-adjusted return merely because of this. This tendency to buy into lottery ticket leads to all sorts of really bad investments:
- Higher volatility stocks have lower return than low volatility stocks
- Higher beta stocks have lower returns than low beta stocks
- out-of-the-money options have lower returns–and higher betas–than in-the-money-options
- higher leveraged firms have lower returns than lower leveraged firms
- firms is greater financial distress have lower returns than firms with low financial distress
- Junk bond mutual fund returns are lower than investment grade mutual fund return over the past 22 years
- sports longshots such as 50-1 odds horses, have lower returns than favorites
- lotteries with the highest payouts have the lowest expected returns
- IPOs have lower-than-average stock returns
[This is in my book, and also summarized on an SSRN paper I wrote here.] Notice a pattern? The more volatile, more uncertain, the lower the return. People pay a premium (accept a lower return) for ‘Black Swans’, because in one fell swoop, they can get rich and prove they were RIGHT! Instant satisfaction. Plus, if you really have the touch, why waste time choosing Coke over Pepsi, when you can choose between GM and Citi!
Basically one would be better off not chasing dreams via Black Swans, and stick to boring investments. Finding alpha–a risk-adjusted return premium–is very difficult, and it involves a niche specific to an individual’s skills, which almost surely is not in investing anymore than the average person has alpha singing or writing romance novels. Black Swan investing is a sucker’s game, endemic in markets, a perennial loser, and highlights asset classes to avoid, not pursue.
Retail traders and investors generally use a lower bar to measure performance: it must make money. Until it doesn’t. Then they say the “market has changed” and go back to square one.