Perry E. Metzger (
Thu, 22 May 1997 12:52:36 -0400

> From: James Rogers <>

> >1) The markets are not perfectly efficient -- perfect efficiency
> > requires perfect information transfer. The fact that markets are
> > ever shifting, products ever changing, information always taking
> > time to diffuse, means they can never be perfectly
> > efficient. However, the markets are pretty damn close to efficient
> > these days -- efficient enough that things like day trading are a
> > risky way to make a living.
> The markets are far from perfect. There are many wildly over-valued
> companies (some over-valued for reasons I can't possibly fathom) and
> many undervalued companies as well. Also, the values of all
> securities are based on the expected *future* value and earnings,
> not the current book value.

You may believe, based on "gut" that the markets aren't efficient, but
the statistics don't bear this out. In particular, attempts at
objective metrics like those used in so-called "Value Investing" turn
out not to work very well.

> >2) It is possible to exploit market inefficiencies to make money. I've
> > seen people who are just too far out of the statistical spectrum to
> > be accidents -- traders like Paul Tudor Jones and Louis
> > Bacon. These people are, however, unusual. I've seen far, far more
> > people who can't manage to trade their way out of a paper
> > bag.
> The keys to making money on the market are sufficient education on how the
> market really works, and doing enough research to make informed decisions.

Of course, the question of what "sufficient education" means is rather
hard to quantify. I've seen many smart people fail miserably in the
markets, or decieve themselves into thinking they were outperforming
the market higher than statistical chaance would permit.

> >3) The people who are guaranteed a place at the banquet are the casino
> > owners. Brokers always get their vig. Traders -- especially
> > amateurs -- don't always do so well. In the futures market, friends
> > of mine at Refco tell me the average time between opening a futures
> > trading account and losing *ALL* your stake is about a year.
> Futures are a very dangerous market to trade; futures are even dangerous to
> seasoned experts. Futures is one of the few markets I will not trade in.
> Amateurs trading futures are foolhardy.

Futures aren't in fact more dangerous than other markets. The reason
they are perceived as dangerous is because they permit so much
leverage. However, there is no real difference between buying an S&P
500 future and buying the S&P 500 as a basket, or between buying wheat
futures and buying wheat. The temptation, however, is to use the
leverage to acquire a position that is too large for you.

BTW, some of the richest men I know became rich in futures trading. On
the other hand, they have lots of expertise and intelligence, and they
are a rare breed. I'd never try it and I don't recommend it.

> >4) The people who do manage to make money "trading" rather than
> > "investing" are almost inevitably full time professionals who are
> > very, very smart -- and even they sometimes "blow up". The author
> > of the famous "Memoirs of a Stock Operator", Larry Livingston,
> > killed himself a few years after writing his book after losing
> > every penny he had.
> There are many successful part-time traders. At every brokerage there are
> one or two clients who average 100% return every year, a small group of
> clients who average 50% every year, and a very large number who average 10%
> a year.

You do realize, though, that just random chance would lead to this
distribution, correct?

What you are advocating is "active investing", the notion that you can
do much better than the market by just putting a fairly modest amount
of time in. I don't really believe that strongly any more. It is
demonstrably possible that you can do better than the market -- but it
isn't easy. Remember, if it was, everyone would do it. The markets
*are* fairly efficient.

> >On the other hand....
> >
> >1) Over the long term, the stock market DOES outperform almost all
> > other investments -- and outperforms it handsomely.
> >2) You don't even have to think much to make money in the markets:
> > passive investments like buying into an S&P 500 following mutual
> > fund do bring their investors excellent returns.
> Safe and profitable, but not aggressively profitable. It will take decades
> to grow a sizeable sum, especially if you are starting small.

Well, "slow and steady wins the race". Better to get a nice steady 15%
a year than zero.

> >3) Even random portfolios of sufficient size do pretty well in
> > general.
> Random portfolios are stupid. You might as well invest in a mutual fund,
> which is probably safer.

I see you haven't been following the research.

In fact, a large random portfolio isn't especially stupid. It tracks
the market average well. Most people can't afford sufficient
diversification to get a large random portfolio -- you need a lot of
different stocks to make one track the market properly -- and you are
likely to do as well far more easily with an index fund, but there is
little reason to refer to a large random portfolio as "stupid", and
there is little reason to believe an active mutual fund to be "safer".

> >4) People who have a slight information edge -- like understanding
> > what a high tech company does -- can sometimes get an advantage
> > even if they aren't full time investors.
> Absolutely.

Note my caution. "Sometimes".

> I have a third option:
> Taking the time to do adequate research and to make informed decisions pays
> off handsomely. I probably spend 20 hours per month doing research and
> educating myself on the market. As a result, I have done very well over
> the years, and far better than the indices. I am usually holding 6 to 8
> stock positions at any one time and have not had a negative month that I
> can remember. To date this year I have averaged ~8% return every month.

This is the question: is your performance truly out of line with the
markets? Absolute returns aren't very interesting -- returns relative
to market, and the statistical likelyhood of getting there by
accident, are far more interesting.

Also, remember -- higher return often is a sign of higher risk.

> Some years are better than others, but I consistently do far better
> than the market by making intelligent trades and not reacting to the
> fluctuations and fickleness of the market (especially the NASDAQ!).
> I rarely hold a stock position more than a year and often no more
> than 6 months.

I'll point out that the second richest man in the U.S., Warren
Buffett, often holds positions for years or decades.

> For those with only small amounts of money to invest (say $50 per month), I
> would recommend investing in growth oriented mutual funds. The brokerage
> houses penalize small trades heavily. Trading stocks starts to become
> economical when you have enough money saved to start buying at least 40-50
> shares per trade.

40 or 50 shares is still too small -- you pay extra commission for odd
lots, and round lots are always multiples of 100 shares except for
oddball stocks like Berkshire Hathaway which trades at $30,000 a share.

> There is some risk involved, but there is no need to put such a grim spin
> on trading. There are many people who make consistent profits as
> part-time, amateur traders.

True enough, but it isn't trivial. *That* you save and invest steadily
is far more important than *if*.

I don't want to sound like a naysayer -- there is nothing wrong with
picking your own stocks. However, it isn't the way most people are
going to become rich, and it is *real work*. If you are better at some
other profession, investment is not the road to getting rich
quick. Indeed -- there ARE no roads to getting rich "quick" that work