Of George Soros' backache signal & different trading positions
Great investors understand risk and reward at an intuitive level
by Adam Levy/Atlanta/Bloomberg
John Maynard Keynes, in his famous 1936 work, General Theory of Employment, Interest and Money, likened the stockmarket to beauty contests that ran in newspapers of his day, in which readers were asked to pick the prettiest face. The key to selecting the winner, Keynes argued, isn’t choosing the face you think is the most beautiful but rather anticipating the face other people will pick.American securities analyst John Burr Williams argued in 1938 that the price of financial assets reflects a measurable intrinsic value, a notion that fits with the value investing approach advocated by Benjamin Graham.
The so-called efficient market hypothesis, popularised by economist Eugene Fama in the 1970s, holds, as Bachelier did, that price changes are random. In other words, no one can forecast markets accurately. According to Fama and his followers, technical traders, who believe they can predict prices by examining patterns of price movements, are wasting their time. Chartists can’t beat the market. No one can, at least not for long. The idea that something other than reason sometimes drives economic decisions is hardly new. Extraordinary Popular Delusions and the Madness of Crowds, written by Charles Mackay in 1841, remains a Wall Street classic to this day.
Mackay examined the history of alchemy, witch hunts, fortunetelling and speculative frenzies such as the mania over tulips that gripped Holland in the early 17th century, when the flower bulbs traded at a higher price than gold. His book shows how otherwise intelligent people sometimes succumb to mass idiocy. Terms used in psychology have become ingrained in the language of investing. A rush for junk bonds or Internet stocks is a “mania”; an economic collapse is a “depression.”
Keynes coined a colourful term for one of the vital ingredients of economic prosperity, the naive optimism that prompts people to cast aside their fears despite all experience: “animal spirits.” Daniel Kahneman, who won the 2002 Nobel Prize in economics for his pioneering work in behavioural finance, which fuses classical economic theory and studies of human psychology, began exploring how investors systematically make judgment errors or mental mistakes in the 1970s. They follow the herd, trade excessively and react too slowly to unexpected news, he concluded. Billionaire investor George Soros, 75, has a theory about why markets behave the way they do. He calls it reflexivity. The gist of it is that markets can’t discount future events correctly because they actually help shape them.
Consider the Nasdaq Stock Market boom and bust of the late ‘90s. Young, money-losing companies depended on their ability to finance themselves in the capital markets.
When stocks are climbing, such companies can raise money easily. A rising stock makes a startup more viable, which leads to an even higher stock price, which makes the company more viable still, and so on and so on.
The same thing happens in reverse when stocks decline. Soros’s son, Robert, has offered his own explanation of his father’s trading success. In Soros: The Life and Times of a Messianic Billionaire (Knopf, 2002), a biography of the money manager written by former New York Times columnist Michael Kaufman, Robert Soros, 42, says of his father: “You know the reason he changes his position on the market or whatever is because his back starts hurting him. He literally goes into a spasm, and it’s this early warning.”
So what makes a great trader? Alan Greenberg, chairman of the executive committee of Bear Stearns Cos, says the successful ones understand risk, absorb information and make quick, calculated decisions. They have the self-confidence to take a loss and move on, he says. Some of these qualities come down to instinct, says Greenberg, 78, who joined New York-based Bear Stearns in 1949 and still sits on a trading desk. Even so, Greenberg doesn’t buy neuroscientists’ claims that such instincts are rooted in our brain.
“Great investors understand risk and reward at an intuitive level,” Griffin, 37, says.
