Markets: Fooled By Randomness


Published on

CastleGate's presentation to Patni Employees.

Published in: Business, Economy & Finance
1 Comment
  • 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.
    Are you sure you want to  Yes  No
    Your message goes here
No Downloads
Total Views
On Slideshare
From Embeds
Number of Embeds
Embeds 0
No embeds

No notes for slide
  • Markets: Fooled By Randomness

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