Then you lost. You were compelled to sell the stock for less than its value.
If you needed ten dollars and you sold a stock to somebody to get the ten dollars and both of you were aware that the stock was worth fifteen dollars, then you lost five dollars and the buyer gained five dollars. That’s what a zero sum game is.
That message was clear enough and every man and his dog has known that for many many years. I wanted to deconstruct the bullshit filigree of non-science.
No I didn’t sell when it was worth fifteen dollars.
I didn’t say it was simple. There’s nothing simple about trying to predict what the future value of a share will be.
I think you are missing that point.
The point was about balancing (and rebalancing) for the sake of risk tolerance. Anxiety reduction has value.
Let’s imagine right now that I have a stock that has done very well, so well that it now represents two thirds of the value of my portfolio. I believe that that equity will continue to do well but having that much of my value in one equity causes me anxiety. I sell off half of it. Now imagine that stock continues to do well.
Did I “lose” half of the additional gain in that stock or gain the reduction of risk and anxiety? Does the answer depend on what I did with the money from the sale and if re-invested in say a diverse basket how well that basket did in comparison?
I get the point that the show was making though - one investor overall doing better than the average, the index, (by active investing) implies someone else doing below the average (by active investing) with a share for the house (costs of trades).
Replace ‘investor’ with any other noun for a human, and that rule you stated still holds true. Fighter-pilot, Chronic farter, Nose-miner.
Here’s a more succinct way to put this.
If, as an active trader, you want to beat the market, you must make trades that either are luckier or driven by more strategy than someone else in the (worldwide) active trading community. If you think about it, if you are just a guy behind a desk somewhere, and other entities actively trading are supported by a whole building full of well paid math PhDs using machine learning, your odds aren’t great. Long term you are more likely to be one of the losers than winners because it’s a zero sum game.
So don’t think of it in terms of “hurting” someone else. Obviously, if you do come out ahead, it was only because you bought securities or options and the market moved in the direction you predicted. Just realize that if you aren’t a successful day trader or hedge fund owner today, and you want to get in on the business, the odds are stacked against you because you have to do better than I guess the ‘average’ entity already on the market, at least in the niche you trade in.
The people getting into examples of ‘what happens each day to x traders’, or dividends specifically etc are confusing themselves with due respect. Look at it top down not bottom up because it’s a top down concept we’re dealing with here.
There’s the total return of the stock market (including dividends). That total return can only be shifted around by any kind of trading or derivatives (stock index futures are the simplest and largest type of derivative in the stock market). The effect of cash stock trading and derivatives must add up to zero* before expenses, but that trading has expenses greater than ‘buy and hold’ , typically. So the players who simply passively hold the index get in aggregate the index return minus lower expenses. The players trading and using derivatives get in aggregate get the index return minus higher expenses. That difference is the ‘negative sum game’ originally referred to.
*shorting cash stock has been mentioned: also strictly zero sum. A short borrows the stock from a long, who is getting the stock’s total return as long as she holds it. The short must sell to another new long (or to the original long but doubling her position, anyway a new long position). The two new positions created by the short sale are strictly zero sum, just like stock futures and traded options are. The ‘natural’ 1X long position of the whole market is earning whatever it is earning. The extra 2X, 3X etc ‘open interest’ created by short sales, futures and options is all zero sum. The only little correction IOW to the basic picture of zero sum game is to account for the total return of the 1X part, ‘fixed sum game’. If anyone captures a 1 more of that fixed sum, somebody else has to capture 1 less.
Not residents of Lake Woebegone though.
But exactly right; it is not a profound insight.
To the degree any of us play at “active investing” we really are best thinking of it as play. Odds are we’d do better in return over time by doing an index or so. This is for fun and ego and maybe for small areas of the market that we actually have great knowledge and insight about.
I readily admit I play a small bit in this way but and to me it’s like going to a casino to play poker. My leaving having done no worse than the indices over time is like leaving a casino with what I came in at: I had fun for no cost.
No, because most positions don’t have the kind of direct exchange that a stock sale is. If you decide to increase the amount you pick your nose, it doesn’t reduce the amount I pick my nose. The amount of nose picking you and I engage in is independent of each other.
That’s not true with a stock sale when you sell me a share of stock. It had a price X that we both agreed on. But it also has a value Y which neither of us know. You’re assuming X is higher than Y and I’m assuming Y is higher than X. But whichever way the value of the stock goes, the difference between X and Y represents a gain for one of us and a loss for the other.
Even though there is a finite amount of any given stock, the total market cap can change, depending on the amount being traded. The mere act of you and I (and thousands others) trading the stock changes the value. And typically we aren’t trading with each other anyway, we are trading with a market maker who maintains a large inventory of stock.
At it’s most basic, a stock is a company issuing shares of ownership in exchange for cash. By definition, not zero sum as the company gains an influx of cash and shareholders gain stocks representing value in the company. Every subsequent transaction is someone exchanging cash for shares of stock so both receive utility. And both parties have the potential to bid up the price.
Zero sum games would be something like poker or chess where there is one winner and the total value of the pot doesn’t change. Options and futures are also zero sum games because in order to make money, the other party has to lose money. But the stock market is not a zero sum game.
The point of the Freakonomics was about active investing in comparison to index investing and the not so profound insight is in fact exactly comparable. As a whole the market and prices responding to those supply-demand forces is not a zero sum game.
It’s just another lecture on why index funds make the most sense for most people and that picking stocks is for most both “stupid” and an act of overconfidence.
Bolding mine.
Overall I think your two posts here capture the reality in the best, most clearly stated way. Bravo.
One of the things that confuses people IMO is that, as you clearly said, the total return is a fixed sum. But it’s an unknowable fixed sum.
Nothing any of us do will change the total return of the US market over 2018. But equally, none of us will know what that fixed number *is *until it was; until 12/31/2018. It’s hard to grok an unknowable fixed number, especially when it seems as if the daily machinations of all of us collectively are what’s moving that Ouija puck and making the annual return to date be anything but fixed.
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Ref the snippet above and the bolded part in particular, I’m going to suggest that history teaches a different lesson.
These more sophisticated instruments do *not *exist “to transfer risk around to whomever is in a better position to take it at a given time.” Instead they exist “to transfer risk to whomever is least aware of the actual risk being transferred to them, and is therefore most willing to be underpaid the most to take it on.”
The persistent mispricing of derivatives, even today, is evidence of a massive informational / decisional disconnect. Some entities are making smart informed buys & sells. Many others are not.
Picking individual stocks isn’t really “stupid”, if your strategy is to pick a diverse batch of blue chip stocks and hold them forever (which for all intents and purposes is a “fund”). I’ve made a number of (fairly obvious) stock purchases during the financial crisis that have mostly paid off.
What is stupid is trying to “market time” individual stocks (trying to buy low and sell high as the market fluctuates). When taking trading costs into account, it is very difficult for people (including professionals) to market time such that they exceed the performance of a “buy and hold” strategy".
Regarding market efficiency, it’s been know for some time now that there are a few very simple investing strategies that have produced higher returns than the market itself - buying smaller capitalization stocks and buying “value” stocks (e.g. stocks with low price-to-book values).
Academics like Ken French argue that you can’t beat the market on a risk-adjusted basis, so small cap stocks have had higher returns historically because they have higher risk (I tend to agree) and value stocks have outperformed because they’re riskier (I don’t see clear evidence for this. It seems to be based on circular reasoning).
Thanks to the Center for Research in Securities Prices (CRSP), we have excellent data for equity returns over the past 90+ years. Over that time period, the smallest 10% of stocks have returned well over 20X the total return of the largest 10%. I don’t have similar data for value stocks but historically the value premium has been even larger than the size premium.
How thoroughly has CSRP’s data been corrected for survivor bias? Serious question; I have no idea myself.
ISTM that however big a factor survivor bias is in the market in general and the various indices, it’ll be a bigger factor the smaller the market cap is of the companies in question.
I don’t think it’s an issue because 1) complete, reliable data for the NYSE was available starting around 1930, and 2) CRSP was set up in 1960 and has been tracking returns in real time ever since.
But the topic here has nothing directly to do with market efficiency or risk. Whether the market is efficient or not, and regardless of risk or risk tolerance, holding the entire market all the time has only one total return. If some invested 's exceed that return by holding only a portion of the market or holding all of it but for only a portion of the time period in question, or both, some other invested 's must underperform that return by the same amount. The average $ can’t outpeform.
Maybe the discussion goes on because the point is so obvious people think some broader claim must be being made.
Although indirectly it’s true that the tautology of under/outperformance is sometimes offered, and reasonably IMO, as at least a point of reflection about the likely existence of opportunities naive investors could use to outperform the market on a risk adjusted basis. ‘Somebody else has to underperform if you outperform*, who do you imagine that it is**?’
*not debatable
** a good question, though not conclusive proof that a given idea by a given person can’t work to beat the market, even ideas like small/value premium every smart $ has known about for ages. It’s just worth thinking about.
ETA: Not meaning to pile on. I simulposted w Corry El
You missed my point.
Unless the number they quoted you included a correction for survivor bias it overstates the actual return an actual investor could have received. Even if there are no math errors and 100% of the stocks in the market are in their database with no goofs or gaps.
If they didn’t say whether they corrected for survivor bias or not in the particular stats you’re reading then we don’t know if they did or didn’t.
To the degree they have not applied survivor bias correction they have overstated the historical available returns to all types of stocks.
IMO small cap stocks are more affected by survivor bias issues than are large caps.
Therefore, to the degree my opinion is right AND they have not applied survivor bias correction they have overstated the relative benefit of small-cap over larger-cap stocks.
If we don’t know whether they did or didn’t that’s fine. It just partly undermines the conclusion you’ve said they present.
The CRSP data for the 91-year period ended 12/31/16 is available at the bottom of page 16 here:
**Annualized Return**
CRSP Decile 1 9.30%
CRSP Decile 2 10.55%
CRSP Decile 3 11.03%
CRSP Decile 4 10.84%
CRSP Decile 5 11.48%
CRSP Decile 6 11.36%
CRSP Decile 7 11.57%
CRSP Decile 8 11.55%
CRSP Decile 9 11.54%
CRSP Decile 10 13.29%
So $1 invested in the largest 10% of publicly traded stocks in 1926 would now be worth $3,269, whereas $1 invested in the smallest 10% of publicly traded stocks would be worth $85,395 (26X as much).
Make of that what you will, but personally I overweight ultra-small stocks and small cap value stocks. This implies that someone else must be underweighting them relative to the market.