In my book Financial Speculation I concluded with this final round of my thoughts and approach to investment.
I think these stand, and will continue to stand, the test of time.
Yeah I know….but
In this concluding section I want to restate some of the major themes of this book. Firstly and most importantly finance is simple but not easy. There is a fashion these days to believe that finance is complicated and wrapped up in complex maths and arcane terminology. This need not be the case; the basics of finance are simplicity itself. The whole business can be seen in terms of three basic actions; buying or selling, borrowing or lending, and executing the transaction now or at a future date. The idea that much of financial activity is based on accruals and annuities; and the fact that financial risk can easily be understood in terms of four simple graphs should not be forgotten.
The hard part of course, is in the doing or the execution of financial business. The vagaries of the inner self, the imponderables caused by time, the nature of volatility, all conspire to make financial speculation a difficult endeavour. On top of this the megaphone advice, research and sales patter that engulf us all is extremely difficult to survive. Experts, gurus, and pundits have an answer for everything and an instant view about the future for every likely paying customer. To be able to shut yourself off from these sirens is perhaps the hardest part of the business.
We also live an age that worships information technology, the computer and the ability to communicate globally on a very cheap basis. All very worthy achievements, but secondary to the business of speculation and finance. The market is not primarily about technology, it is not just about software packages and the latest developments in global bandwidth; it is still a business about judgement and skill.
History is another overlooked area within financial markets; in the manic atmosphere of always wanting to know what’s next, we are in danger of forgetting the bigger picture. In finance there truly is nothing new under the sun; of course markets have got more sophisticated, the pricing of risk has probably become more accurate, and trading volumes and activity have exploded in the last twenty five years. But the basic themes and underlying cycles are still in place; their amplitude and frequency may change but the core characteristics still hold true. Much money can be made by studying long term relationships and understanding the linkages between various asset classes. The prevailing orthodoxy that markets should be analysed and traded in narrow vertical sectors is myopic and stupid.
Magic solutions don’t exist, econometric models, technical analysis, high frequency data analysis, genetic algorithms, kernel regression systems et al; none of them will give you the perfect answer. They may be right some of the time, but we must remember that markets are dynamic not static. By this we don’t just mean the prices move constantly, but that the characteristics and emotions of a market are in constant flux; it’s virtually impossible that a static system can capture all of this activity on a consistent on going basis. Flexibility is a key attribute in investment, and systems by definition are usually too rigid.
Performance claims by others must be viewed with a particularly critical eye; ignore the marketing drivel about fund manager’s league tables, industry award and surveys, and out performing pointless benchmarks. The only test is how much money, you or your investment manager made. Is it consistent? Is it sustainable? Does the manager understand the market or have they just been lucky in a bull market? Much is made of transparency in today’s markets but the case for clearer and more accurate investment information still remains unanswered.
Perhaps one of the best ways forward is in the realm of behavioural finance. This has grown in popularity in recent years as more research has been done into the decision making processes of market participants, and on trying to understand their motives and rationale for their actions. It may be a cliché but understanding ourselves may in fact be more important than understanding the markets. How we act under pressure is perhaps more vital than trying to predict any sudden move or surprise. Learning to control ourselves is much more attainable than trying to learn how to control markets.
Because we are all different in our approach and our capacity for risk we will find that different ideas and angles suit us best in trading; that is why it is pointless to get hung up on one idea that seems to work for someone else.
Costs are, as we have seen, another overlooked but dangerously toxic area. The costs of constantly trading can be vast; in trading, less is often more. Rushing around like a madman constantly trading is stupid, your broker will love you, but your bank manager maybe very concerned. So called ‘small’ costs such as brokerage, spread and the hidden factor of slippage are potentially fatal, only the greenest of newcomers fail to understand this. Also losses are natural, it is hard to say that we should welcome them, but we have to get used to them; they are constant visitors in this world.
Finally remember that speculation and investment is about understanding the difference between price and value. Fashions come and go; pet theories, big market names and high finance ideas ebb and flow; but correctly understanding the relationships between price and value remains the key. Every investor or speculator has to find that out for themselves; and for many of us it remains a hard battle. Don’t believe anyone who says it is easy – they are misleading you. As I said earlier it’s simple to understand but not easy to do.
I will leave the very last comment to that titan amongst American bankers J.P. Morgan who when buttonholed by an anxious journalist outside the New York Stock Exchange during a period of anxiety was asked what the market would do next. Morgan fixed the journalist with a calm stare and coolly replied “Fluctuate!”