Thursday, October 23, 2014

This Halloween I’m Dressing as a Stockbroker

In a typical October, the trees shed their leaves and stocks shed their value. This one is no exception. During Halloween month, the scariest place is not the cemetery but Wall Street – not so much for the traders, who (unless trading on their own accounts) make money regardless of what the market does, but for the rest of us.

Very few “rules of thumb” for investors stand the test of time. There is a random element to price movements that baffle even expert analysts. For two decades Alan Greenspan was the most respected central banker in the world, yet in his latest book he admits he totally misread the movements of asset prices while in office. What hope is there for the rest of us? Strangely enough, one idiotically simple rule of thumb has been a winner for centuries: “Sell in May, go away.” The months November-April really have had better returns than May-October; October in particular repeatedly has been nasty indeed. A hypothetical investor who put $10,000 in stocks reflecting the S&P in 1958 (a recession year) and then followed the sell-May-buy-November strategy now would have a portfolio of $544,323. The reverse strategy (buy-May-sell-November) would leave the investor in 2014 with $9,728, a $272 loss. Professional investment advisers tend to pooh-pooh the sell-May strategy, because it seems to make no sense. To them it has the smell of superstition: an unreliable interpretation of a statistical oddity. Yet it is hard to dismiss the persistence of the pattern. Besides, it does make sense in human psychological terms, if not in terms of the underlying economic realities. Octobers are bad for the market because Octobers historically are bad for the market. It is self-reinforcing. Investors, aka humans, are jittery creatures when they suspect bears are about, either in the woods or in the market; they know October is an especially ursine infested month, and flee on hearing the first scary rustle or grunt.

Beyond this simple calendar trick, investment strategies by individuals and professionals alike are surprisingly useless. Often worse than useless. Several years ago Terry Odean, professor of finance at Berkeley, analyzed 163,000 trades in 10,000 individual brokerage accounts. Clearly the account-holders expected to benefit by the trades, i.e. do better than if they simply had held the stocks they sold. Yet, overall, the stocks they sold did better than the stocks they bought by an average of 3.2 percentage points. (Why? The human tendency to sell stocks that are up from their purchase price and to keep those that are down until their prices recover – “loss aversion” – meant they dumped their strongest stocks and ended with a weaker portfolio.) Odean and his colleague Brad Barber published an oft-quoted paper called Trading is Hazardous to Your Wealth, which demonstrated that active traders on average do worse than less active ones. Individuals who simply hold a diversity of stocks can expect to track the market. Beating the market rate of return is a matter of luck, and luck, as we know, is fickle.

 “Experts” are scarcely better with their stock picks. When Nobel-winning economist Daniel Kahneman was preparing a talk for investment advisers he received a wealth of data on their performance from their employing (well-known) firm. The advisers’ bonuses were based on the performance of their investment picks, so they had every incentive to choose well. His analysis of the data: “The results resembled what you would expect in a dice-rolling contest … the firm was rewarding luck as though it was skill.” To be sure, there really is a substantial amount of education and skill required to count as a financial expert. Few people understand how some of the more arcane derivatives really work. There is a huge amount of information (product lines, industry trends, balance sheets, corporate culture, etc.) to be evaluated when trying to make an informed judgment about a particular company. Yet, the informed judgments prove to be as hit and miss as the uninformed, for there are always more factors than what you see. As for whether the company is overvalued or undervalued (whether the stock will fall or rise), “Traders apparently lack the skill to answer this crucial question, but they appear to be ignorant of their ignorance.”

Well, as Socrates noted some time ago, this is not an uncommon human condition. I don’t pretend to be immune to it. I’ve never followed the sell-in-May strategy, for one thing, though I’d be far far better off if I had. My informed picks (not only in finances, alas) usually have been worse than my random ones. Yet it’s hard not to overthink the next decision anyway, even knowing that it won’t help. That, I suppose, is human, too.

1929, the archetypical Crash. Mr. Forbes' advice to buy was off by a few years: 1932 was market bottom. 1933 was the best year ever for stocks (yet to be surpassed) even though the Depression would last until 1940.


  1. I'm not totally sure I fully understand the "sell in May, go away" theory. Are they saying completely dump your "entire" portfolio, and then buy back in next year at some point?

    I usually just buy and hold, and sell when I feel I need too. That way pay less broker fees, and overall it seems like I do better that way, plus I don't have to go thru all the trading. If a stock goes down, yet still in good standings, I'll buy more to income average my price of it downward. (Buy low, sell high.)

    A lot of pundits of the market poo poo this "grey beard" strategy, but I think it still has validity, and is still the basic approach for the Motley Fools, and Peter Lynch, so it works for me too. Here's an article:

    Go down to the second chart:
    Annualized Return, and you'll see Buy & Hold does the best of all at a 10% return.

    Here's another article:

    Another reason I like to buy and hold, if you happen to capture a good company, something like, for example, Apple, Amazon, Disney or whatever good company you wish to apply, why lose the good price you bought in at? Keep it, and continue to add to it if there's a slump in the market. That's basically how a mutual or index fund works or is suppose to work, and people screw up with those as well. You are supposed to hold them over a long term of years working for the company, and add to them thru thick and thin years, the ups and down years--that way, you average your price out in the lean, bear markets. Unfortunately, what some people do is stop adding to their fun in recessions or downturns due to fear and uncertainly, which is when they should be buying and adding to the fund (to buy at a lower price--or income average the price lower). Then when the market jumps up again, and they finally become aware of it, they get back in, but the prices for stocks has stabilized by then, they may miss the rise back up, and they don't get much gain or return for their money.

    They indeed should have just left it alone, and continued to add funds from their paycheck thru thick & thin, and the same for individual stocks.

    Granted there are times to sell, when a company goes bad or whatever, bad news on a company or they continue to miss earnings (or) you've earned a lot off the company, and you want to take a gain. If it's a good enough company you can take your gain, and let the rest ride because your gain was significant enough to pay for the price you bought it at--or that would be the ideal strategy.

    Here are 13 Steps to Investing Wisely (the Motley Fools say, Investing Foolishly, but that's their trademark, so they use that instead to play upon their trademark).

    1. Yes the idea is to sell your holdings in May and buy them back 6 months later. There is no good reason why this should work, but historically it does.

      Buy-and-hold is a generally wise approach. Boring, perhaps, but wise choices usually are.

      Professional traders, unlike individuals investing for themselves, don't actually do worse than the market, but they don't do any better. On average, that is. Naturally, traders fall on a bell curve: most track the market while some overperformers and underperformers outlie on the tails. But you would expect that distribution simply by chance. Perhaps in some cases overperformers really do owe their success to skill rather than luck, but the overall numbers don't demonstrate it.

      That said, I enjoy reading sites like Motley Fool too.