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6,362 posts
msg #29613
Ignore TheRumpledOne
11/2/2003 11:34:00 PM Perspectives
For the week ending November 2, 2003

In this week's issue:
Weekly Commentary
Strategy of the Week
Stocks That Meet The Featured Strategy

A young woman, intent on becoming a successful stock trader, went to see the Stock Prophet for words of guidance.

"Oh great Stock Prophet, tell me how to learn your wisdom and become a profitable investor. I am not well spoken in the ways of the market, but yearn for the knowledge that can help me make money in stocks. Where should I begin?" asked the woman.

The Stock Prophet replied, "Begin at the beginning is what you must do. But understand that before you begin you may be ahead of those who have already found an end. For it is the bad habits and the gathering of misleading knowledge that will hurt you more. With no knowledge, you have nothing that can hurt you, and only room for gain. It is often the experience of fools that is most difficult to break. Go now, and learn the basics."

With that, the young woman departed from the Stock Prophet's hallowed ground, unsure of where to go but intent on learning the basics. She eagerly studied all that she could read about the market, but much of it left her discouraged. She decided to return to the company of the Stock Prophet and again seek his counsel.

"Oh great Stock Prophet, I have studied all the basics of stock market theory. I have read the works of the most well known of financial theorists, but it leaves me with little hope for success. They argue that market efficiency takes away all opportunity for market beating profits, and that it is only luck to have a great market beating return. However, over the long run, good luck will be offset by bad, and I can only hope to earn what the market earns. Historically, that is only 7% or 8%, which will hardly earn me a good living. I am not sure that I can go any further in my quest if that is the destination."

The Stock Prophet looked at the young woman with amused admiration, and after a long pause, spoke to her.

"You have gone down the path that a great many have gone, and opted to do what has always been done. But remember, those who always do what has always been done, will always get what others have always received. To rise from the crowd of mediocrity, you must see what others do not see."

"The argument of the learned is a good one, and the market will only hurt you if you do not respect the theory of market efficiency. The use of publicly available information to make investment decisions is dangerous, for all that is known publicly is already priced in to the stock. The rational deduction of well known facts can only lead to what the market has already determined, and the successful implementation of such effort will produce random success and failure. But there is more that you must know."

"There are two important assumptions of market efficiency that you must question. First is the assumption that the spread of fundamental information is equitable. Second, that market participants always make rational decisions. If these two things are always true, then your pursuit must end here. But seek out the more recent thoughts of academic laureates, and find a greater truth."
The young woman again left the Stock Prophet, perhaps more confused now than ever. What greater truth was she supposed to find? What had she missed?

The Stock Prophet had given a clue which she eventually hit upon. Academic laureates! She must read the works of those who had attained Economics' greatest prize. After reading the works of recent Nobel Prize winners, she eagerly went back to see the Stock Prophet, filled with a greater optimism, but still unsure of what the next step would be.

"Stock Prophet, oh wise Stock Prophet, I have studied the wisdom of Nobel Prize winners and found that which you sent me to find. The two assumptions of market efficiency are not always true! The spread of information is not always fair, there are many times when information is attained by small groups before the general public. And second, investors are not always rational, it seems the market can be filled with emotion."

"You have studied well, but how will you use your knowledge?" asked the Stock Prophet.

"That is what I am unsure of," replied the woman. "If I am to capitalize on breakdowns in market efficiency, I must focus on stocks where information is not being spread evenly, or on stocks that trade with emotion instead of rational judgment. But I can not hear all the whispers of private information, nor can I see in to the hearts and minds of every investor. I fell like I know the answer, but am powerless to use its wisdom."

A bemused smile came across the Stock Prophet's face again. He liked this woman, she was smart and determined, but had not yet seen what only a successful trader could see. He again spoke to her,

"It is true, you can not know the emotions that each investor feels, nor can you possibly be on the inside track of every company's fundamentals. But you can count on one thing, and that is that the effect of each of these factors can be measured. Just as a pollster predicts the political future, you too can predict the market future. To understand where stocks are going, you must learn to follow the footprints of the well informed, and feel the mood of the crowd. Successful stock investing requires an ability to read market activity and understand its message. Go now, and study some more."

Somewhat dejected, the young woman went away again to pursue her aim. "This Stock Prophet sure seems to like messing with my mind," she thought to herself.

With greater fervor than ever before, she studied more, this time focusing on the analysis of stock charts. If market activity was the key, then she must learn how to read the dissemination of information and the mood of the market from stock charts. The patterns that occurred in the stock chart seemed of central importance, some told stories of optimism while others indicated pessimism. Abnormal occurrences on the stock chart often came shortly before significant fundamental changes were made public. It was amazing how much the stock chart could tell, and how well it could predict the future. After much studying, the young woman became confident that she could predict the stock market well enough to make money trading. She went to the Stock Prophet one last time, to express her thanks.

"Oh Stock Prophet, you have led me on a journey of discovery, and I have found its end. I can now predict where stocks will go, and am ready to make my career as a stock trader. I have learned all the basics of financial theory and I know everything there is to know about the technical analysis of stocks. I see how the breakdowns in market efficiency create opportunity, and I will now boldly aim to take advantage of that breakdown. I have come this one last time to offer my gratitude for all that you have done to help me in my quest. I promise that I will not forget you when I have made my fortune."

The Stock Prophet had heard this so many times before. Many others had made this revelation, but the Stock Prophet knew that very few of them had found their way from wisdom to wealth. He spoke again, eager to not see his favorite student go down a road destined to end in despair.

"It is good to hear that you have found the knowledge and confidence that your study should bring. But before you go, let me impart one last piece of wisdom. I have seen many before you with the same knowledge, but who have only failed in the difficult quest for market mastery. You see, there are many systems for picking stocks, many methods that seem to create market beating returns. But despite the obvious correlation between wealth and the ability to predict markets, it is not this predictive ability that will create your success. Instead, it is important that you do not fall in to the emotional traps of those who have gone before you."

"Successful traders never speak of their system for picking stocks. Instead, they focus on their ability to manage risk effectively. They see the importance of a disciplined approach to trading. They understand the need to not be afraid of losses, and to avoid the pursuit of pleasure in investing. A good trader is not made by his or her knowledge of the market, they are instead made by their knowledge of themselves. They learn to overcome the emotional programming that all humans undergo through their lives. The avoidance of pain and the pursuit of pleasure are what will make even the best of trading methods a dream that is never realized. Until you understand what this means, trade the markets with great caution."

The young, aspiring trader turned away from her mentor yet again, this time with a calm and determined disposition. She felt that she finally knew all that was necessary. She knew how to pick stocks, but to make money, she now understood that she would also need to learn how to master her inner self. With that, she went to study some human psychology. It seemed that was the holy grail of stock market success.

6,362 posts
msg #39655
Ignore TheRumpledOne
12/18/2005 6:07:15 PM

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