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Markets: Fooled By Randomness
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Markets: Fooled By Randomness

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CastleGate's presentation to Patni Employees.

CastleGate's presentation to Patni Employees.

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  • This was a really nice presentation! I loved the book 'fooled by randomness' ... this presentation touches on some of the same ground, but is also a bit of a broader look at securities investing, and what can trip people up when making decisions about their investments.
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Markets: Fooled By Randomness Presentation Transcript

  • 1. Fooled By Randomness CastleGate Capital Company
  • 2. Financial Markets Brief Introduction To Some Aspects
  • 3. What Is A Good Investment
    • Minimum Transaction Cost
    • Minimum Constraint Of Choice
    • Ability To Identify Value
    • Increase In Value
    • Increase In Value Greater Then Criteria
      • Inflation
      • Return Expectation
      • Opportunity Costs
    • Ability To Exit
    • Should Satisfy Time Horizon
    • Whether an investment was a good or bad investment is only decided by the difference in the price you paid versus the price you get at the end of your time horizon
  • 4. What is the market?
    • Features Of a Free Market
      • Transparency
      • Default Free
      • Settlement Procedures
      • Anonymity
      • Liquidity
      • Fair
      • Regulated
      • Free From Manipulations
  • 5. What is value
    • Ways of measuring value
    • Dependence of value of assumptions
    • Role of subjectivity in assumptions
  • 6. Components of a stock’s value
  • 7. Indicators Method For Avoiding Madness
  • 8. Indicators as Anchors
    • What is an Indicator
    • How when every euphoria exists indicators can become good anchors of sanity
    • How are indicators calculated
    • Leading vs Lagging Indicators
  • 9. Simple Indicators
    • What’s a Book Value
    • P/BV Ratio
    • What Is Dividend Yield
    • During times of optimism more money is being paid for a stock, reducing it’s Dividend Yield and increasing P/BV ratio
    • The more they diverge, greater is the danger of bubble
  • 10. Metal Stock Vs Price Indicator
    • Here the stock piles of metals are measured as grey line
    • The metal prices, obviously are inversely related to stock piles. Higher the stocks lower the prices
    • This indicator can serve as a warning for not getting into Metal Companies for now, not investing in LONG METAL TRADES in commodities etc.
    • Almost doubling of prices since 2000 indicates Metal Stocks may be doubled in last 2-3 years, but this will not be a good time to buy them
  • 11. Indicators Of Transition
    • Consider a company with revenue of 100 Cr.
    • Small Cap Company
    • Default Level Caa-C
    • Probability of rev. 500 Cr
  • 12. Complex Indicators
  • 13. Where Money Will Flow Next
  • 14. The Reality Of Complexity If You Not Inside, You Are Outside
  • 15. Conflict Of Interest
    • A deal begins at least 6 months before it arrives in press
    • Professionals working on it know the impact of the deal on markets
    • Information flows openly in India
    • Investment Research and Investment Banking
    • How real is the Chinese Wall
    • Triple layers of research reports
    • Insider networks
  • 16. Broker Performances
    • Lets consider the reports they write
    • For a buy report,
      • Lets find the best price the stock reached
      • The worst price
      • How many days (as % ) since then did the stock stay above report days price
    • Will you like a recommended stock whose best price was 5% up, worst was 30% down and was below report day’s price for 90% of the times
    • According to Bloomberg, best broker has been Merrill Lynch with 35% accuracy, can you imagine the rest?
  • 17. Top Broker’s Predictions: ENAM
  • 18. Enam Downside
  • 19. Top broker’s predictions: SSKI
  • 20. Mutual Funds
    • Large institutions are 70% of funds
    • They have specific requirements in terms of risk and time
    • Not to mention the kick backs paid to get in such large clients
    • The funds are run to manage their requirements and not small investors
    • When a large guy gets out with his funds, the fund manager has to sell for redemption irrespective of good or bad time
    • The broker’s bill is paid by the investors who stay behind reflected through NAV which nobody notices
    • Margins have upper cap of 1%, cost cant be reduced, only way to make money is to collect more funds
    • Fund Managers Incentive structure
    • On Mutual Fund distribution structure
    • 29 Fund houses 2000 schemes which one to buy.
    • Too few fund managers managing too many funds with diverse objectives
  • 21. Derivatives
    • Futures
    • Options
      • Put
      • Call
    • Leverage
      • Non linearity of returns
      • Magnification of gains/losses
    • Underlying Dangers
      • Too Many Parameters
      • Quick Exit Scenarios
      • Margin Calls/ Position Liquidation
      • Stop Loss Triggering
  • 22. Dangers Of Derivatives
    • Legendary investor Warren Buffet compares derivatives to Financial Weapons of Mass Destruction
    • http://www.berkshirehathaway.com/2002ar/impnote02.html
  • 23. Options: If you can’t calculate this you are gambling on slim chance
  • 24. Psychology Of Finance Sins Of Fund Management
  • 25. Folly Of Forecasting
    • Roots in pride of being smarter then others
    • Anchoring: Tendency to stick to numbers for support
  • 26. Experiments
  • 27. The Point Being
    • Pride
    • Ego Defense Mechanism
    • Debasing
  • 28. Past Versus Future Earnings
  • 29. The Illusion Of Knowledge
    • More Information is not better judgment
    • More information only increases confidence
    • Over information can be detrimental to decision making
    • Information vs Noise
    • Few key information is preferred
  • 30. Experiments
  • 31. Davis Et Al (1994)
    • Davis asked people to forecast 4Q earnings based on last 3 Q EPS, Sales, and Stock Price
    • This was baseline info
    • Later Extra (Relevant and irrelevant information was added
    • Just the presence of extra information increases errors
    • Both redundant and relevant information increase confidence with relevant information to a greater extent
    • Accuracy remains just declines redundant or relevant
  • 32. Knowing Management Helps
    • Corporate Managers Cognitive Illusions
    • Confirmatory Bias
    • Figures of Authority
    • Separating Deception From Truth
  • 33. The Overoptimistic Manager
  • 34. Confirming To The Manager
    • Leeper, Lord and Ross (1979) on confirmatory bias
    • Mind finds information that agrees with its views
    • Contradicting information is hard to assimilate
    • Biased Assimilation
    • Capital punishment studies
    • Information distortion to favor current leading view
    • Distortion higher in professionals then in students
  • 35. Obeying Authority
    • Milgram (1974) paper on why people obey authority
    • ‘ Students’ and ‘Teachers’ experiment for seeing effect of ‘Shock On Memory’
    • Man in white coat and glasses made as teachers
    • Three levels of shocks
    • Subjects can only hear the screams but cannot see them
    • People delivered highest levels of shocks only because they were told by ‘Figure of Authority’
  • 36. Telling Deception
    • Kassin Et Al studies
    • 61 students and 57 federal investigators to identify mock confessions
    • Audio/Video
    • 53% accuracy, just the same as chance
    • When it was told that 50% of them will be accurate, students had a better judgment rates then professionals
    • When training is given to ‘Students’ the number of false alarms increases
    • Catching a deception is not so easy
  • 37. Overtrading: Myopia Of Short Termism
    • Attention Deficit Hyperactivity Disorder
    • Incentives of Fund Managers
      • Better to fail conventionally than to succeed unconventionally
    • Reducing average holding periods of stocks
  • 38. Fire The Fund Manager
  • 39. Believing What You Read
    • Stock brokers sell greed
    • The Allure of growth
    • Dangers of story view
    • Spurn The Spin
  • 40. On Belief Systems
    • Cartesian Vs Spinoza Belief Systems
    • Challenge or Upset beliefs
    • Avoid all beliefs
    • Go away from the noise
  • 41. Conclusion
    • There is no free lunch
    • That investment is not a casual game but alert frugal patient investor’s game of silent and continuous practice
    • Financial Markets are not a place to display you RISK TAKING ABILITY
    • They are a place to show your Minimum Risk Maximum Return Finding Ability