Conrad
Number of posts: 5647
Location: Amsterdam, the Netherlands
Registration date: 2007-07-21
 | | Subject: Interesting article about the proper use of models Tue May 05, 2009 8:10 am | |
| economic models, not super models here| Quote: | Someone using mathematical models for investing is betting that his models are going to be better able to anticipate future market conditions than are the efforts of others to do the same.
Here are some principles of using financial models that emerge from these considerations:
* You must have reason to think that you've discovered an existing pattern before others have. Therefore, if "everyone" knows about a model, forget about it. The disappearance of the "Dogs of the Dow" effect once it became widely known is an example of this. The technique consisted of buying the 10 Dow stocks with the highest dividend yield and holding them for at least a year. After it became popularly known, it underperformed the market in 1998 and 1999, had a mediocre return in 2000, and lost money in 2001.
* You must constantly watch for the pattern dissipating, because eventually it will. Either market conditions will change, or others will start to perceive the outlines of your model. The profits you are earning are always temporary. You must watch the results of the model carefully, to see when its applicability begins to fade.
* A corollary to the above: Be prepared to innovate and find new patterns if you want to keep playing. Never stop trying to develop, or trying to find from others who have developed, new models, even while the old ones are still making profits.
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Finally, never trust anyone--including yourself--who says he has a universal system for trading securities. Such a system implies that we will arrive at the evenly rotating economy, or at least a financial-market-wide equilibrium. As we saw above, it also implies all market participants attempting to buy or sell at the same time. |
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Stewart
Number of posts: 1202
Location: Boston, MA
Registration date: 2008-04-02
| | Subject: Re: Interesting article about the proper use of models Tue May 05, 2009 9:07 am | |
| I think an important proviso to this is that it only applies to mathematical models which are intended to beat the market. Outperforming everyone else isn't a necessary goal of investing, and in fact it's a goal which is--to my naive eyes, anyway--probably a good sign that what you're doing isn't really investment after all. |
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Conrad
Number of posts: 5647
Location: Amsterdam, the Netherlands
Registration date: 2007-07-21
| | Subject: Re: Interesting article about the proper use of models Tue May 05, 2009 10:31 am | |
| | Stewart wrote: | | I think an important proviso to this is that it only applies to mathematical models which are intended to beat the market. Outperforming everyone else isn't a necessary goal of investing, and in fact it's a goal which is--to my naive eyes, anyway--probably a good sign that what you're doing isn't really investment after all. |
you speak like Harry Browne! |
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Guest
Guest
| | Subject: Re: Interesting article about the proper use of models Tue May 05, 2009 11:32 am | |
| I was going to say, it sounds like Harry Browne. Smart guy. Also read Stirner. Heh. |
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Static4367
Number of posts: 353
Age: 30
Location: Los Angeles, CA
Registration date: 2008-05-22
| | Subject: Re: Interesting article about the proper use of models Tue May 05, 2009 1:47 pm | |
| | Stewart wrote: | | I think an important proviso to this is that it only applies to mathematical models which are intended to beat the market. Outperforming everyone else isn't a necessary goal of investing, and in fact it's a goal which is--to my naive eyes, anyway--probably a good sign that what you're doing isn't really investment after all. |
This certainly applies to individual investing, but for corporate investors models become a necessity. Institutional investors have to take a much more rigorous approach both because of the amount of money they are managing and the number of covariances (inter-relationships) between the broad range of securities they are holding. In an institutional context "beating the market" also becomes more ambiguous. Portfolio managers are compared against narrowly defined benchmarks representing a small subset of the market, or sometimes even custom defined.
For these types of investors there are really two main dangers:
Assuming the assumptions of your model are valid representations of the real world and confusing correlation with causation.
The former was the big one in our current crises. Institutional investors/traders of all sorts forgot that their models relied on very significant macro-economic assumptions and failed to consider the possible outcomes if their macro assumptions were completely wrong. |
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