Stock Market Crashes
On Monday, October 19, 1987 , the Dow Jones Industrial Average lost 23%. By noon of the following day stocks faced a crisis where some people feared a total collapse of the stock market. The U.S. Federal Reserve, led by a recently appointed Alan Greenspan, rode to the rescue by guaranteeing certain trades. The market recovered in the afternoon of October 20. Many people have investigated the 1987 stock market crash. Of note, independent studies were performed by Professor Robert Shiller, the author of Irrational Exuberance, and by his friend Professor Jeremy Siegel, the author of Stocks for the Long Run. 1
These two leading academics are often on opposite sides of the stock debate. Professor Shiller argued (correctly so) that stocks were overval ued in the late 1990s. On the other hand, Professor Siegel has maintained a uniformly positive view of stocks, before, during, and after the bursting of the bubble in 2000. Because of their opposing views on the prospects for stocks, they are often contrasted as leaders of the bear and bull camps .....
Markets Are More Than Simply Irrational—They Can Be Mean
Investors seem to have an uncanny ability to be wrong about investments. We tend to be optimistic about stocks just before market collapses and pessimistic just before bull markets. Consider the experience of U.S. investors in the period from 1965 to 1981
The Dow Jones Industrial Average ended 1965 at 969, and 16 years later the index stood at 875. Almost an entire generation passed with the stock market going absolutely nowhere. Near the end of this period, peo ple essentially forgot about stocks, and in 1980 only 5.7% of households owned any mutual funds .....
Photographic Evidence: Scientific Evidence of Sentiment Predicting Stock Price Changes
Professor Richard Thaler, doyen of the behavioral school, and Professor Werner DeBondt performed a systematic analysis of sentiment. 16 They hypothesized that people would feel good about rising predict stock price and feel bad about falling stocks. Therefore, they predicted that the future performance of stocks that made investors feel bad (the losers) would be better than that of stocks that made investors feel good (the winners).
Professors Thaler and DeBondt thus predicted that a way to make money is precisely to buy the hated stocks that had been losers. They performed a systematic study of hundreds of stocks over many years. In each period they constructed a portfolio of previous winners and previous losers.They then compared the performance of their winner and loser portfolios ...
Some People Get Rich by Selling High and Buying Low
Over the last 40 years, Warren Buffett has increased the value of Berkshire Hathaway at a compounded rate of 22.2% per year. Over the same period, the S&P 500 stocks have increased by 10.4% a year; $1,000 invested with Warren Buffett at the start of this period would have been worth $2,594,850 at the end of 2003 versus $47,430 for an equivalent investment in the S&P 500. stock investing, stock trading online, research stock market, hot stock, stock trade, forex. So Warren Buffett seems to have a pretty good record of buying and selling at favorable prices—prices that the efficient markets hypothesis suggests should never exist. Furthermore, Warren Buffett seems to have done a lot better than a dart-throwing monkey ....
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Photographic Evidence: Predicting Coin Flips
If Warren Buffett's success in the past was luck, then the efficient markets hypothesis suggests that for next year he is not expected to outperform the market or a dart-throwing monkey. In this thought experiment the "winner" who produces 10 heads in a row has exactly a 50% chance of producing an eleventh head on the next coin flip, the same odds as a loser who produced 10 tails in a row ....
A Hypothesis Masquerading as a Theory
During the war of 1812, the Native American Chief Tecumseh captured the fort of Detroit through an interesting ruse. In the conflict, federal and state troops, under the command of Major-General Hull, vastly outnumbered about 1,000 Native American warriors. Tecumseh had his fighters run out of the woods and then secretly circle back to emerge again. General Hull saw—and counted—the same warriors over and over and was fooled into thinking he faced a vastly larger force. He surrendered without a shot ....
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Sell the Fads, Buy the Outcasts
Opportunities occur periodically in many different markets. In all cases, winning requires a willingness to challenge the conventional wisdom. During the inflationary 1970s, Andrew Tobias, the personal finance guru, literally had to deal with a mob in order to profit from an irrationally high silver price. 21
Throughout the inflationary 1970s the price of silver rose by more than 1,000% until it exceeded $40 an ounce. At the height of the frenzy, Tobias decided to sell some of his physical silver. He went to a retail location that bought and sold precious metals including silver and gold. As he approached the store he saw a huge crowd and thought it was too late. Everyone, he supposed, had realized that the price of silver was too high and had gathered to sell.
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An Instinct for Losing Money
A cartoon I saw posted over a trader's desk on Wall Street read, "Definition of a quandary: Should I sit back and watch the market soar or buy now and cause it to plummet?"
In some areas our natural tendencies take us to good outcomes. My wife's recent pregnancy comes to mind as one such area. During the early part of pregnancy, the growing fetus is especially sensitive to certain naturally occurring toxins(teratogens).
According to Margie Profet, who won a MacArthur Foundation "genius" award for her work on this subject, pregnant women are built to avoid foods that include fetus-damaging toxins (teratogens). 23 She provides evidence that pregnant women are nauseated by such foods, particularly cabbage-family vegetables like broccoli and cauliflower that have high levels of damaging compounds. If Profet is correct, then in the area of food choice, pregnant women ought to follow their instincts and eat whatever tastes good ....