Original text came from one of the highest iq in the world (not mine)., and is currently paid to acess or accessed for members inside a High Iq society.
For @quepasta @N30N @Kaari
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INVESTMENTS X SPECULATIONS
TRADITIONAL INTERPRETATION.
In 2005, when I was just starting to get interested in investing, and I mentioned the subject to Thomas Case, he told me that investing in Forex is not “investment”; it is “speculation”. According to him, investing is investing in real estate.
The traditional understanding of these two concepts can be summarized as follows:
Speculating is operating in the Financial Market, making decisions based exclusively on the behavior of quotations and traded volumes, using indicators such as the Relative Strength Index (RSI), Moving Averages (MA, LMA, EMA, SMA), Bollinger Bands (BB), MACD, candlestick patterns, Finonacci levels, Elliot waves, LTAs, LTBs and other Technical Analysis indicators. In general, the health of the company or the sector is not taken into account, nor is the economic situation of the country or the world.
Investing is operating in the Financial Market by making decisions based on the quality of the company's management, the ratio between Price/Earnings (P/L), Price/Tangible Asset Value (P/VPA), D/CS = Company Debt/Share Capital, Net Cash Flow (NCF), Return on Capital (ROE) and other Fundamental Analysis indicators. With these and other criteria, one tries to assess the health of the company, as well as how the main social, political, economic, climate and other variables affect prices. In the case of investments in real estate, LCAs, Treasury, commodities and other financial instruments, decisions are made based on equivalent criteria.
It is also common to classify as “investment” when the application aims to control the company whose shares are being acquired, or participate in the management, voting on deliberations between partners and contributing to the company's growth. A link is established with the company in which the investment is being made and the investment is usually “held” for relatively long periods (at least a few years), so the choices take into account factors that tend to be maintained in the long term.
In turn, the term “speculation” is usually used when the investment is not intended to use the acquired asset, but rather to wait until it increases in value and then sell it at a profit. A long-term link is not established with the company, there is no concern about interfering in the management or contributing to the company’s growth. The operations are usually much shorter.
There are other ways in which one can try to describe the usual interpretation of the concepts of “investment” and “speculation”, but they are essentially quite similar to those described above.
TYPICAL PROFILE OF INVESTORS AND SPECULATORS.
In general, those who follow Fundamental Analysis, Value Investing, and Buy & Hold are people with assets well above the average for the Brazilian population (generally in the top 1% of income). They are more educated, usually with higher education, more cultured, and more intelligent (in the top 5%). They are people who have already acquired or inherited considerable assets and want to protect these assets from the effects of inflation. If they also make some profit, all the better, but their main goal is not to get rich from the investment, since they have generally already achieved good financial stability and primarily want to maintain what they have already achieved. Because they are more intelligent and well-informed, they know that an average profit of 5% per year above inflation already represents a very attractive gain. According to the study carried out by FGV, cited in the “Presentation” of our website, we can see that among 1,000 funds analyzed, only 18 (less than 2%) generated profitability greater than 5% per year above inflation in the last 5 years. And if the period considered were longer than 5 years, the number of funds that would remain at this level would be even lower.
Followers of Technical Analysis, Charting, Daytrading, Scalping, Swing trading, Tape Reading, are people who are still trying to achieve financial independence and dream of getting rich without having to study or work, by some easy route. They are easy victims for course and book sellers, believing in the illusion that a Technical Analysis course lasting a few months will teach them something that will make them more successful than if they had followed the “normal” path of undergraduate, master’s, doctorate and then tried to get a director position in some company, or self-employed/entrepreneur. Often they are not even remotely informed about how much the best managers in the world earn (in percentage terms), and create expectations that are completely unrealistic, setting goals that cannot be achieved and, in order to try to achieve these goals, they end up taking extreme risks and suffering huge losses.
This is the general view that people have of “speculation”, “investment”, “speculator” and “investor”. But is this really the case?
In fact, the typical profile of Fundamental Analysis followers is as described above, as is the profile of Technical Analysis followers. Some Technical Analysis users make money selling courses, then lose money on the stock market using the techniques they teach their students. Other Technical Analysis users lose money on all sides, paying for courses that will not give them any useful knowledge and then losing even more using these techniques to trade.
SOME FACTS ABOUT FUNDAMENTAL ANALYSIS.
The complete inefficiency of Technical Analysis strategies is a well-known fact among the most experienced and sensible investors. But does Fundamental Analysis work better? Before continuing, it may be interesting to read my article in which I discuss the difference between Technical Analysis, Scientific Analysis, Philosophical Analysis and Rhetorical Analysis. In short, quantitative methods can be divided into 2 subgroups:
1. Scientific Analysis, which is the most efficient, safest and most profitable of all.
2. Technical Analysis, which is the least efficient and loses the fastest.
Both Scientific Analysis and Technical Analysis are based on historical quotes and quantitative methods, with the difference that Scientific Analysis is firmly based on Scientific Methodology, with rigorous and systematic experiments to test each hypothesis, while Technical Analysis is based on the personal opinions of people who were unable to make money trading, so they decided to try to make money by selling courses and books. A good example of a Scientific Analyst is James Simons. With very few exceptions, almost all other quantitative analysts are technicians.
Fundamental Analysis can also be divided into 2 subgroups:
3. Philosophical Analysis, which is the second most efficient, safe and profitable.
4. Rhetorical Analysis, which is equivalent to operating randomly.
Both Philosophical Analysis and Rhetorical Analysis are based on subjective analyses of macroeconomic phenomena, with the difference that Philosophical Analysis has propositional rigor and, therefore, internal consistency, leading to better-founded interpretations, although difficult to weigh due to the absence of a metric that establishes the relative importance of different phenomena. Rhetorical Analysis is an attempt to be Philosophical, but lacks analytical rigor and often involves fallacies that compromise internal consistency. Buffett is a good example of a philosophical analyst, as are some of the best fundamental analysts in the world. With the exception of these, the rest are, for the most part, rhetorical.
Several experiments have been carried out comparing the profitability obtained by fundamentalist professional managers with the profitability generated through random operations, and the results observed were convincing. One of the most famous cases is analyzed in our article “Why People Lose in Investments”, in which an article published in the Wall Street Journal is mentioned, in which the results of 100 professional managers are compared with the results of 1 chimpanzee. The human managers used their fundamentalist indicators, they used the teachings they acquired in their Economics, Political Science, Administration courses, they used what they learned in the most famous books on Investments, they used the experience they acquired over the many years they worked in the Market. On the other hand, the chimpanzee chose his portfolio by throwing darts at a board on which were the names of the shares. Detail: the chimpanzee did this blindfolded. After 1 year, they compared the profitability of the managers with that of the chimpanzee and found that, in terms of risk-adjusted profitability, the chimpanzee outperformed the managers.
We are not talking about just any stock market. We are talking about the New York Stock Exchange, the largest stock market in the world. And we are not talking about doctors, lawyers, engineers, or businesspeople who dedicate a few hours a day to studying the Financial Market, as amateurs, and trying to make a few bucks from it. We are talking about professional managers, generally hired by large banks to manage multimillion-dollar funds. How can you explain that a chimpanzee has selected a better portfolio than the fundamentalist managers on Wall Street?
In the article “Why People Lose in Investments”, this question of why the chimpanzee obtains results equivalent to those obtained by professional managers is addressed in a very didactic way, so I will not repeat it here.
WHY DO FUNDAMENTAL ANALYSTS WIN WHILE TECHNICAL ANALYSTS LOSE?
The reason why some fundamental analysts are able to make profits, while practically all technical analysts are unable to do so, is not because fundamental strategies are superior, nor because the criteria that fundamentalists use are better. The reason is extremely simple: while a fundamental analyst makes one trade every 2 years and pays R$10.00 in brokerage fees every 2 years, a technical analyst can make more than 10 to 100 trades per day, and pays R$50,000.00 to R$500,000.00 in brokerage fees every 2 years. A fundamental analyst spends R$10.00 in brokerage fees; a technical analyst spends R$50,000.00 to R$500,000.00! In addition to the brokerage fees, the cost of spreads usually reaches a similar cost to the brokerage fees. This difference is the reason why fundamental analysts win, while technical analysts lose.
Therefore, both technicians and fundamentalists use methods with the same inefficiency as a chimpanzee, with the difference that technicians perform a much larger number of operations and thus generate a much higher cost of brokerage and spreads. Another point is that technical analysts often like to operate with leverage, which accelerates losses.
As we analyzed in the “Presentation” section of our website, if we consider the evolution of the Dow Jones index from 1776 to 2006, and discount inflation, we see that the average appreciation of shares is around 1.46% per year. Therefore, on average, the random purchase of shares, or the selective purchase, which are basically the same thing, generates an average real profit of 1.46% per year. Thus, as long as you do not spend more than this profit by executing many operations per day, as technical analysts do, you end up with a small real gain. Even when you add up the costs of fees, custody and settlement, it is still possible to be positive if the number of transactions is small. Remember that this profit of 1.46% per year is the historical average, but in some periods of high stock market growth, you can earn much more than 10% per year, just as you can lose more than 10% per year in periods of low stock market growth.
When a fundamental analyst goes through one of these periods of high stock market growth, and spends 3 years... 4 years... 5 years... earning more than 10% per year, it is very easy for him to create the illusion that this will last forever, and conclude that this is the average profitability he can expect to obtain for the rest of his life, but all it takes is for a period of low stock market growth to bring him back to reality.
Fundamental Analysis, Value Investing, Buy & Hold are comparatively much better practices than Technical Analysis, but the actual profits obtained are much lower than one might think, and the periods below the high-water mark are also much more frequent and longer than one might think, as can be seen in the graphs in our “Presentation” section.
Given this scenario, we are led to reflect: is Fundamental Analysis really a form of investment? Or is it just a safer and less expensive form of speculation?
What the facts show us is indisputable: with the exception of very rare people in the world (about 1 in every 1,000,000 people), such as Buffett, Soros, Lynch, etc., the vast majority generate results indistinguishable from those that would be obtained by a blindfolded chimpanzee. When a person combines the necessary ingredients to win in the Financial Market (talent + dedication), and manages to obtain consistent gains of 5% per year above inflation, maintaining these gains even in times of crisis, this person will manage funds, as is the case with Stuhlberger, Bodin, Damasceno and a few others. When a person is unable to stay positive by operating in the Market, he or she tries to earn in some other way, selling courses, providing investment consultancy, writing books, opening a brokerage firm, opening a Family Office, etc.
If the person is among the 0.0001% of the population that has the necessary attributes to earn above average, consistently, he or she will open a fund. If not, is there any way for him or her to obtain substantial gains? A similar question was asked to Ed. Seykota, and he responded that the person should hand over his or her money to be managed by an exceptional manager. However, Seykota does not explain how to select such a manager.
HOW TO EVALUATE AND SELECT THE BEST INVESTMENT ALTERNATIVES.
Evaluating the competence of a manager or the efficiency of a strategy is not as simple as evaluating the quality of a chocolate or a car. It only takes a few seconds to evaluate the quality of a chocolate and you don't need to have technical knowledge to do so. It only takes a few hours to evaluate the main characteristics of a car, even without much technical knowledge. However, to evaluate the efficiency of an investment strategy or the competence of a manager, you need to have access to a considerable volume of data on the manager's performance history, as well as knowledge of a whole arsenal of statistical tools to correctly interpret the strengths and weaknesses evidenced in this history. This difficulty leads the vast majority of people to choose their investments based on inappropriate criteria, such as the prestige and financial size of the entity selling the investment, instead of analyzing the inherent virtues of the investment itself. By doing so, they are trusting that a large bank has selected the best managers, but in reality neither the bank's founder, nor the directors, nor the HR professionals know how to evaluate whether a manager is really good.
The funds offered by banks are operated by the bank's own brokerage firm, so each transaction, whether positive or negative, generates profit for the bank in the form of brokerage fees, in addition to other fees. The bank's interests are not well aligned with the client's interests. It may be the case that some funds offered by banks are really good, but they represent a rare exception. Most funds offered by banks are terrible and become negative in less than 3 years of activity, without ever getting above the high water mark.
In the case of Family Offices, they usually receive a fixed salary for the work they do, but little or no compensation for the quality of the funds they recommend to their clients, which also creates a certain misalignment of interests with the client. Family Offices do not need to work hard to find the best investments for their clients. They just need to select typical investments, which is quite easy, does not require much work, does not require much knowledge or much competence. Family officers just need to be sycophantic and subservient, and their clients will be happy to entrust their assets to their care.
Neither banks nor Family Offices have sought to understand the strategy used by the funds, nor the tests carried out to select and validate these strategies, nor the experiments to verify whether performances tend to be maintained in the long term. The criteria they adopt are generally based on bureaucratic and arbitrary details, which, in addition to being useless, also run the risk of excluding some of the best alternatives.
In this bleak scenario, there is no point in consulting the bank manager or a Family Office to find the best investments. When an investor realizes this, they reach the final step and understand that the only way is to seek, on their own, to learn how to correctly identify and evaluate the best investment alternatives, to perceive the weak and strong points in a manager, a fund and in any type of investment. That is why reading the articles on our website is highly recommended. Even if the person does not pass our questionnaires to be able to invest using Saturno V, they will certainly become more capable of making better choices, some of which are even mentioned on our website, such as Verde Asset, Dynamo Coughar, Tempo Capital.
NEW INTERPRETATION OF THE CONCEPTS OF “INVESTMENT” AND “SPECULATION”.
Having clarified all these points, we can now address the main topic of this article: the difference between “investment” and “speculation”.
In Chess, a speculative move is one that is not known whether it is good or bad, but that is estimated to have a reasonable probability of being good, because it appears to be good based on an approximate analysis, an analysis without the necessary rigor and depth to ensure that it is in fact good. This concept of “speculation” seems to me more appropriate to describe “financial speculation”.
In this context, operating in the Financial Market in a speculative manner consists of making decisions based on incomplete, insufficiently rigorous and insufficiently in-depth analyses, generally using subjective criteria. Thus, both Fundamental Analysis and Technical Analysis can be classified as “speculation”, depending on the rigor and depth with which the analyses are performed, depending on the criteria adopted, the methodologies, etc.
And what differentiates an investment from speculation is that the investment is made based on systematic, in-depth studies, solidly grounded in objective data, with an appropriate statistical approach and following the best protocols of scientific methodology. Thus, James Simons can be classified as one of the few investors in the world who truly deserves to be classified as an “investor”. In fact, he is also the biggest and best investor, with an average annual performance of 35% per year since 1982 in his Medallion fund, and with more than 85 billion dollars under management in his Renaissance Technologies management company. When comparing these results with those obtained by the legendary Warren Buffett, of 22% per year, it is clear that the use of quantitative and objective methods is superior to the subjective methods of Fundamental Analysis.
When analyzing Graham's teachings in the book “The Intelligent Investor”, it is clear that he does not actually teach an objective and concrete method for making investment decisions. He only makes a series of notes and gives several opinions about what he thinks. He does not present scientific studies that support his personal beliefs, although he presents seductive philosophical arguments. Since he and some of his students and followers have achieved good results, especially Buffett, the success of these people ends up leading crowds to the incorrect conclusion that the teachings of this book can help someone make money in the Financial Market at a greater level than a chimpanzee. But all 100 professional managers who competed with the chimpanzee had also read this book, in addition to many other books.
So how can we explain that Buffett and some others have achieved success by reading this work?
By 2017, more than 3 million copies of “The Intelligent Investor” had been sold, and it had probably been read by more than 10 million people. The number of people in the world with consistent positive results for more than 20 years must be very small. In Brazil, I believe there are only 3 funds that meet this criterion, and perhaps in the world there are between 100 and 1000. So, out of 10,000,000 people who read this book, about 100 (to 1000) of these people were actually able to obtain consistent profits from it, remembering that these 100 (to 1000) generally read many other books as well, which makes it difficult to associate success with this particular reading, or even to ensure that this reading contributed in any way to the success achieved. I believe this is one of the 5 or 10 best books on the subject, but even so it does not contribute to helping the reader earn consistently in the Market.
This leads us to conclude that the success of Graham's followers cannot be attributed to reading this work, or any other author's work, or even to the sum of all the books they have read. The reason they have achieved success is a combination of remarkable talent, a lot of study and dedication over several years to understand how the Market Works.
Update: a few minutes after publishing this article, my friend João Antonio sent this comment:
"In a part where you say that "a lot of study and dedication" is necessary, I think it would be interesting to clarify that the study would be primarily about empirical data, the real world, not reading books. I believe that many may have the interpretation that it is primarily about reading books, as this is what they traditionally know as "study", especially because school generally cuts off independent thinking in many cases."
Graham's book certainly provides many clues, which less than 0.1% of readers end up being able to take advantage of and convert into a small competitive advantage, which, added to other small advantages obtained through clues from other books and mainly through direct study of the Market, observing how different political, economic, social, climatic, geological events, etc., affect prices, ended up discovering methods capable of generating profits slightly higher than random purchases and sales, which is why they manage to outperform a chimpanzee. It is not what they read in a book, or in several books, but rather what they themselves discovered and invented from the analysis of the effects of Macro Economics on stock prices, that allowed them to develop winning strategies.
EXAMPLES OF TECHNICAL SPECULATION.
(i cant show this part for you guys, sorry).
CONCLUSION
After analyzing the results of some of the most famous fundamental analysts in Brazil and some of the most famous technical analysts in Brazil, we can see that although fundamentalists can obtain better results than technical analysts, this is not due to the fact that they use a more efficient strategy, but rather to the fact that they execute fewer operations per year and, therefore, are less burdened with fees and spreads. We also saw that the concepts of “investment” and “speculation” can be interpreted more appropriately, considering the theoretical models behind the strategies that guide the decision-making processes and the empirical experiments that corroborate these theories. When a strategy finds broad support in the experimental data, proving to be superior to the results that would be obtained by random operations, then it is an investment. When the results of a “strategy” do not present a statistically significant advantage compared to the results obtained by random operations, then it is speculation. This new way of conceptualizing “investment” and “speculation” is fairer, because it includes funds like Medallion, the best in the world since 1982, in the “investment” class, and revises the classification of more than 99% of the funds that lose to the index using fundamental analysis, and are now classified as “speculation”. In addition to being fairer, the new concepts are also more useful, because they provide investors with the opportunity to evaluate the available alternatives with better criteria, separating the wheat from the chaff.
For @quepasta @N30N @Kaari
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INVESTMENTS X SPECULATIONS
TRADITIONAL INTERPRETATION.
In 2005, when I was just starting to get interested in investing, and I mentioned the subject to Thomas Case, he told me that investing in Forex is not “investment”; it is “speculation”. According to him, investing is investing in real estate.
The traditional understanding of these two concepts can be summarized as follows:
Speculating is operating in the Financial Market, making decisions based exclusively on the behavior of quotations and traded volumes, using indicators such as the Relative Strength Index (RSI), Moving Averages (MA, LMA, EMA, SMA), Bollinger Bands (BB), MACD, candlestick patterns, Finonacci levels, Elliot waves, LTAs, LTBs and other Technical Analysis indicators. In general, the health of the company or the sector is not taken into account, nor is the economic situation of the country or the world.
Investing is operating in the Financial Market by making decisions based on the quality of the company's management, the ratio between Price/Earnings (P/L), Price/Tangible Asset Value (P/VPA), D/CS = Company Debt/Share Capital, Net Cash Flow (NCF), Return on Capital (ROE) and other Fundamental Analysis indicators. With these and other criteria, one tries to assess the health of the company, as well as how the main social, political, economic, climate and other variables affect prices. In the case of investments in real estate, LCAs, Treasury, commodities and other financial instruments, decisions are made based on equivalent criteria.
It is also common to classify as “investment” when the application aims to control the company whose shares are being acquired, or participate in the management, voting on deliberations between partners and contributing to the company's growth. A link is established with the company in which the investment is being made and the investment is usually “held” for relatively long periods (at least a few years), so the choices take into account factors that tend to be maintained in the long term.
In turn, the term “speculation” is usually used when the investment is not intended to use the acquired asset, but rather to wait until it increases in value and then sell it at a profit. A long-term link is not established with the company, there is no concern about interfering in the management or contributing to the company’s growth. The operations are usually much shorter.
There are other ways in which one can try to describe the usual interpretation of the concepts of “investment” and “speculation”, but they are essentially quite similar to those described above.
TYPICAL PROFILE OF INVESTORS AND SPECULATORS.
In general, those who follow Fundamental Analysis, Value Investing, and Buy & Hold are people with assets well above the average for the Brazilian population (generally in the top 1% of income). They are more educated, usually with higher education, more cultured, and more intelligent (in the top 5%). They are people who have already acquired or inherited considerable assets and want to protect these assets from the effects of inflation. If they also make some profit, all the better, but their main goal is not to get rich from the investment, since they have generally already achieved good financial stability and primarily want to maintain what they have already achieved. Because they are more intelligent and well-informed, they know that an average profit of 5% per year above inflation already represents a very attractive gain. According to the study carried out by FGV, cited in the “Presentation” of our website, we can see that among 1,000 funds analyzed, only 18 (less than 2%) generated profitability greater than 5% per year above inflation in the last 5 years. And if the period considered were longer than 5 years, the number of funds that would remain at this level would be even lower.
Followers of Technical Analysis, Charting, Daytrading, Scalping, Swing trading, Tape Reading, are people who are still trying to achieve financial independence and dream of getting rich without having to study or work, by some easy route. They are easy victims for course and book sellers, believing in the illusion that a Technical Analysis course lasting a few months will teach them something that will make them more successful than if they had followed the “normal” path of undergraduate, master’s, doctorate and then tried to get a director position in some company, or self-employed/entrepreneur. Often they are not even remotely informed about how much the best managers in the world earn (in percentage terms), and create expectations that are completely unrealistic, setting goals that cannot be achieved and, in order to try to achieve these goals, they end up taking extreme risks and suffering huge losses.
This is the general view that people have of “speculation”, “investment”, “speculator” and “investor”. But is this really the case?
In fact, the typical profile of Fundamental Analysis followers is as described above, as is the profile of Technical Analysis followers. Some Technical Analysis users make money selling courses, then lose money on the stock market using the techniques they teach their students. Other Technical Analysis users lose money on all sides, paying for courses that will not give them any useful knowledge and then losing even more using these techniques to trade.
SOME FACTS ABOUT FUNDAMENTAL ANALYSIS.
The complete inefficiency of Technical Analysis strategies is a well-known fact among the most experienced and sensible investors. But does Fundamental Analysis work better? Before continuing, it may be interesting to read my article in which I discuss the difference between Technical Analysis, Scientific Analysis, Philosophical Analysis and Rhetorical Analysis. In short, quantitative methods can be divided into 2 subgroups:
1. Scientific Analysis, which is the most efficient, safest and most profitable of all.
2. Technical Analysis, which is the least efficient and loses the fastest.
Both Scientific Analysis and Technical Analysis are based on historical quotes and quantitative methods, with the difference that Scientific Analysis is firmly based on Scientific Methodology, with rigorous and systematic experiments to test each hypothesis, while Technical Analysis is based on the personal opinions of people who were unable to make money trading, so they decided to try to make money by selling courses and books. A good example of a Scientific Analyst is James Simons. With very few exceptions, almost all other quantitative analysts are technicians.
Fundamental Analysis can also be divided into 2 subgroups:
3. Philosophical Analysis, which is the second most efficient, safe and profitable.
4. Rhetorical Analysis, which is equivalent to operating randomly.
Both Philosophical Analysis and Rhetorical Analysis are based on subjective analyses of macroeconomic phenomena, with the difference that Philosophical Analysis has propositional rigor and, therefore, internal consistency, leading to better-founded interpretations, although difficult to weigh due to the absence of a metric that establishes the relative importance of different phenomena. Rhetorical Analysis is an attempt to be Philosophical, but lacks analytical rigor and often involves fallacies that compromise internal consistency. Buffett is a good example of a philosophical analyst, as are some of the best fundamental analysts in the world. With the exception of these, the rest are, for the most part, rhetorical.
Several experiments have been carried out comparing the profitability obtained by fundamentalist professional managers with the profitability generated through random operations, and the results observed were convincing. One of the most famous cases is analyzed in our article “Why People Lose in Investments”, in which an article published in the Wall Street Journal is mentioned, in which the results of 100 professional managers are compared with the results of 1 chimpanzee. The human managers used their fundamentalist indicators, they used the teachings they acquired in their Economics, Political Science, Administration courses, they used what they learned in the most famous books on Investments, they used the experience they acquired over the many years they worked in the Market. On the other hand, the chimpanzee chose his portfolio by throwing darts at a board on which were the names of the shares. Detail: the chimpanzee did this blindfolded. After 1 year, they compared the profitability of the managers with that of the chimpanzee and found that, in terms of risk-adjusted profitability, the chimpanzee outperformed the managers.
We are not talking about just any stock market. We are talking about the New York Stock Exchange, the largest stock market in the world. And we are not talking about doctors, lawyers, engineers, or businesspeople who dedicate a few hours a day to studying the Financial Market, as amateurs, and trying to make a few bucks from it. We are talking about professional managers, generally hired by large banks to manage multimillion-dollar funds. How can you explain that a chimpanzee has selected a better portfolio than the fundamentalist managers on Wall Street?
In the article “Why People Lose in Investments”, this question of why the chimpanzee obtains results equivalent to those obtained by professional managers is addressed in a very didactic way, so I will not repeat it here.
WHY DO FUNDAMENTAL ANALYSTS WIN WHILE TECHNICAL ANALYSTS LOSE?
The reason why some fundamental analysts are able to make profits, while practically all technical analysts are unable to do so, is not because fundamental strategies are superior, nor because the criteria that fundamentalists use are better. The reason is extremely simple: while a fundamental analyst makes one trade every 2 years and pays R$10.00 in brokerage fees every 2 years, a technical analyst can make more than 10 to 100 trades per day, and pays R$50,000.00 to R$500,000.00 in brokerage fees every 2 years. A fundamental analyst spends R$10.00 in brokerage fees; a technical analyst spends R$50,000.00 to R$500,000.00! In addition to the brokerage fees, the cost of spreads usually reaches a similar cost to the brokerage fees. This difference is the reason why fundamental analysts win, while technical analysts lose.
Therefore, both technicians and fundamentalists use methods with the same inefficiency as a chimpanzee, with the difference that technicians perform a much larger number of operations and thus generate a much higher cost of brokerage and spreads. Another point is that technical analysts often like to operate with leverage, which accelerates losses.
As we analyzed in the “Presentation” section of our website, if we consider the evolution of the Dow Jones index from 1776 to 2006, and discount inflation, we see that the average appreciation of shares is around 1.46% per year. Therefore, on average, the random purchase of shares, or the selective purchase, which are basically the same thing, generates an average real profit of 1.46% per year. Thus, as long as you do not spend more than this profit by executing many operations per day, as technical analysts do, you end up with a small real gain. Even when you add up the costs of fees, custody and settlement, it is still possible to be positive if the number of transactions is small. Remember that this profit of 1.46% per year is the historical average, but in some periods of high stock market growth, you can earn much more than 10% per year, just as you can lose more than 10% per year in periods of low stock market growth.
When a fundamental analyst goes through one of these periods of high stock market growth, and spends 3 years... 4 years... 5 years... earning more than 10% per year, it is very easy for him to create the illusion that this will last forever, and conclude that this is the average profitability he can expect to obtain for the rest of his life, but all it takes is for a period of low stock market growth to bring him back to reality.
Fundamental Analysis, Value Investing, Buy & Hold are comparatively much better practices than Technical Analysis, but the actual profits obtained are much lower than one might think, and the periods below the high-water mark are also much more frequent and longer than one might think, as can be seen in the graphs in our “Presentation” section.
Given this scenario, we are led to reflect: is Fundamental Analysis really a form of investment? Or is it just a safer and less expensive form of speculation?
What the facts show us is indisputable: with the exception of very rare people in the world (about 1 in every 1,000,000 people), such as Buffett, Soros, Lynch, etc., the vast majority generate results indistinguishable from those that would be obtained by a blindfolded chimpanzee. When a person combines the necessary ingredients to win in the Financial Market (talent + dedication), and manages to obtain consistent gains of 5% per year above inflation, maintaining these gains even in times of crisis, this person will manage funds, as is the case with Stuhlberger, Bodin, Damasceno and a few others. When a person is unable to stay positive by operating in the Market, he or she tries to earn in some other way, selling courses, providing investment consultancy, writing books, opening a brokerage firm, opening a Family Office, etc.
If the person is among the 0.0001% of the population that has the necessary attributes to earn above average, consistently, he or she will open a fund. If not, is there any way for him or her to obtain substantial gains? A similar question was asked to Ed. Seykota, and he responded that the person should hand over his or her money to be managed by an exceptional manager. However, Seykota does not explain how to select such a manager.
HOW TO EVALUATE AND SELECT THE BEST INVESTMENT ALTERNATIVES.
Evaluating the competence of a manager or the efficiency of a strategy is not as simple as evaluating the quality of a chocolate or a car. It only takes a few seconds to evaluate the quality of a chocolate and you don't need to have technical knowledge to do so. It only takes a few hours to evaluate the main characteristics of a car, even without much technical knowledge. However, to evaluate the efficiency of an investment strategy or the competence of a manager, you need to have access to a considerable volume of data on the manager's performance history, as well as knowledge of a whole arsenal of statistical tools to correctly interpret the strengths and weaknesses evidenced in this history. This difficulty leads the vast majority of people to choose their investments based on inappropriate criteria, such as the prestige and financial size of the entity selling the investment, instead of analyzing the inherent virtues of the investment itself. By doing so, they are trusting that a large bank has selected the best managers, but in reality neither the bank's founder, nor the directors, nor the HR professionals know how to evaluate whether a manager is really good.
The funds offered by banks are operated by the bank's own brokerage firm, so each transaction, whether positive or negative, generates profit for the bank in the form of brokerage fees, in addition to other fees. The bank's interests are not well aligned with the client's interests. It may be the case that some funds offered by banks are really good, but they represent a rare exception. Most funds offered by banks are terrible and become negative in less than 3 years of activity, without ever getting above the high water mark.
In the case of Family Offices, they usually receive a fixed salary for the work they do, but little or no compensation for the quality of the funds they recommend to their clients, which also creates a certain misalignment of interests with the client. Family Offices do not need to work hard to find the best investments for their clients. They just need to select typical investments, which is quite easy, does not require much work, does not require much knowledge or much competence. Family officers just need to be sycophantic and subservient, and their clients will be happy to entrust their assets to their care.
Neither banks nor Family Offices have sought to understand the strategy used by the funds, nor the tests carried out to select and validate these strategies, nor the experiments to verify whether performances tend to be maintained in the long term. The criteria they adopt are generally based on bureaucratic and arbitrary details, which, in addition to being useless, also run the risk of excluding some of the best alternatives.
In this bleak scenario, there is no point in consulting the bank manager or a Family Office to find the best investments. When an investor realizes this, they reach the final step and understand that the only way is to seek, on their own, to learn how to correctly identify and evaluate the best investment alternatives, to perceive the weak and strong points in a manager, a fund and in any type of investment. That is why reading the articles on our website is highly recommended. Even if the person does not pass our questionnaires to be able to invest using Saturno V, they will certainly become more capable of making better choices, some of which are even mentioned on our website, such as Verde Asset, Dynamo Coughar, Tempo Capital.
NEW INTERPRETATION OF THE CONCEPTS OF “INVESTMENT” AND “SPECULATION”.
Having clarified all these points, we can now address the main topic of this article: the difference between “investment” and “speculation”.
In Chess, a speculative move is one that is not known whether it is good or bad, but that is estimated to have a reasonable probability of being good, because it appears to be good based on an approximate analysis, an analysis without the necessary rigor and depth to ensure that it is in fact good. This concept of “speculation” seems to me more appropriate to describe “financial speculation”.
In this context, operating in the Financial Market in a speculative manner consists of making decisions based on incomplete, insufficiently rigorous and insufficiently in-depth analyses, generally using subjective criteria. Thus, both Fundamental Analysis and Technical Analysis can be classified as “speculation”, depending on the rigor and depth with which the analyses are performed, depending on the criteria adopted, the methodologies, etc.
And what differentiates an investment from speculation is that the investment is made based on systematic, in-depth studies, solidly grounded in objective data, with an appropriate statistical approach and following the best protocols of scientific methodology. Thus, James Simons can be classified as one of the few investors in the world who truly deserves to be classified as an “investor”. In fact, he is also the biggest and best investor, with an average annual performance of 35% per year since 1982 in his Medallion fund, and with more than 85 billion dollars under management in his Renaissance Technologies management company. When comparing these results with those obtained by the legendary Warren Buffett, of 22% per year, it is clear that the use of quantitative and objective methods is superior to the subjective methods of Fundamental Analysis.
When analyzing Graham's teachings in the book “The Intelligent Investor”, it is clear that he does not actually teach an objective and concrete method for making investment decisions. He only makes a series of notes and gives several opinions about what he thinks. He does not present scientific studies that support his personal beliefs, although he presents seductive philosophical arguments. Since he and some of his students and followers have achieved good results, especially Buffett, the success of these people ends up leading crowds to the incorrect conclusion that the teachings of this book can help someone make money in the Financial Market at a greater level than a chimpanzee. But all 100 professional managers who competed with the chimpanzee had also read this book, in addition to many other books.
So how can we explain that Buffett and some others have achieved success by reading this work?
By 2017, more than 3 million copies of “The Intelligent Investor” had been sold, and it had probably been read by more than 10 million people. The number of people in the world with consistent positive results for more than 20 years must be very small. In Brazil, I believe there are only 3 funds that meet this criterion, and perhaps in the world there are between 100 and 1000. So, out of 10,000,000 people who read this book, about 100 (to 1000) of these people were actually able to obtain consistent profits from it, remembering that these 100 (to 1000) generally read many other books as well, which makes it difficult to associate success with this particular reading, or even to ensure that this reading contributed in any way to the success achieved. I believe this is one of the 5 or 10 best books on the subject, but even so it does not contribute to helping the reader earn consistently in the Market.
This leads us to conclude that the success of Graham's followers cannot be attributed to reading this work, or any other author's work, or even to the sum of all the books they have read. The reason they have achieved success is a combination of remarkable talent, a lot of study and dedication over several years to understand how the Market Works.
Update: a few minutes after publishing this article, my friend João Antonio sent this comment:
"In a part where you say that "a lot of study and dedication" is necessary, I think it would be interesting to clarify that the study would be primarily about empirical data, the real world, not reading books. I believe that many may have the interpretation that it is primarily about reading books, as this is what they traditionally know as "study", especially because school generally cuts off independent thinking in many cases."
Graham's book certainly provides many clues, which less than 0.1% of readers end up being able to take advantage of and convert into a small competitive advantage, which, added to other small advantages obtained through clues from other books and mainly through direct study of the Market, observing how different political, economic, social, climatic, geological events, etc., affect prices, ended up discovering methods capable of generating profits slightly higher than random purchases and sales, which is why they manage to outperform a chimpanzee. It is not what they read in a book, or in several books, but rather what they themselves discovered and invented from the analysis of the effects of Macro Economics on stock prices, that allowed them to develop winning strategies.
EXAMPLES OF TECHNICAL SPECULATION.
(i cant show this part for you guys, sorry).
CONCLUSION
After analyzing the results of some of the most famous fundamental analysts in Brazil and some of the most famous technical analysts in Brazil, we can see that although fundamentalists can obtain better results than technical analysts, this is not due to the fact that they use a more efficient strategy, but rather to the fact that they execute fewer operations per year and, therefore, are less burdened with fees and spreads. We also saw that the concepts of “investment” and “speculation” can be interpreted more appropriately, considering the theoretical models behind the strategies that guide the decision-making processes and the empirical experiments that corroborate these theories. When a strategy finds broad support in the experimental data, proving to be superior to the results that would be obtained by random operations, then it is an investment. When the results of a “strategy” do not present a statistically significant advantage compared to the results obtained by random operations, then it is speculation. This new way of conceptualizing “investment” and “speculation” is fairer, because it includes funds like Medallion, the best in the world since 1982, in the “investment” class, and revises the classification of more than 99% of the funds that lose to the index using fundamental analysis, and are now classified as “speculation”. In addition to being fairer, the new concepts are also more useful, because they provide investors with the opportunity to evaluate the available alternatives with better criteria, separating the wheat from the chaff.
