There’s a hypothetical scam that I’ve seen outlined in two trading books now, and I think it’s clever so I want to share it. A book I’m reading right now kind of turns its idea inside-out, with scary implications.
Anyway, the scam goes like this: Say you want to grow your investment advisory business. One way to do it would be to mail out 10,000 newsletters predicting next month’s market direction. In 5,000 of the letters, predict up. In the other 5,000, predict down. At the end of the month, 5,000 people will think you understood something about the markets. So, next month, mail those 5,000 people another prediction (2,500 up, 2,500 down). Repeat, and after five months, about 300 people will think you have been right about the markets every month. Of course they will want to subscribe to your service to get your stock picks.
Cute, right? The book I was reading today, though, turned that scam inside out, and presented it like this: Say 10,000 traders commit their money via coin toss, either bullish or bearish on the markets. After 5 months, one would expect that as many as 300 of them will have made money every single month. Two or three will make money every month for a year. You can see by extension, with a large enough population of traders, some will be multi-year market superstars. Articles will get written about them, explaining how their superior methods led to their great success. Others will start following their trades, and seek their advice. Then one day, their luck will run out, but people will forget about that pretty quickly, replacing them with the next two or three lucky traders.
This book I’m reading, Fooled By Randomness, is slowly making me sick. I’m a fast reader, but I’ve had inordinate trouble finishing it–it’s taking a lot of willpower to pick it up. I think it’s because I don’t want to hear what it has to say. He’s making a pretty good case for a lot of so-called success in the markets being plain luck. And it’s not the run-of-the-mill efficient market crap, either. Being long in the market these last couple weeks hasn’t done a lot for my dispositon, as well! :-) I’d rather not read about luck when I have two positions hovering near their stops!
On the bright side, the author is a trader by profession, so he must not think it’s all hopeless. But, I’m 2/3 of the way through, and I’m still waiting for the part of the book that explains why there is some hope for us. It’s demoralizing!