Randomness applied to financial markets

Academics and writers have devoted much effort to studying patterns of random success in the financial markets. There is much evidence, for instance, that the performance of stocks is random – or so close to being random that in the absence of insider information and in the presence of a cost to make trades or manage your portfolio, you can’t profit from any deviations from randomness. Nevertheless, Wall Street has a long tradition of guru analysts, and the average analyst’s salary, at the end of the 1990s, was about $3 million. 

How do those analyst do? According to a 1995 study, the eight to twelve most highly paid “Wall Street superstars” invited by Barron’s to make market recommendations at its annual roundtable merely matched the average market return. Studies in 1987 and 1997 found that stocks recommended by the prognosticators on the television show Wall $treet Week did much worse, lagging far behind the market. And in a study of 153 newsletters, a researcher at the Harvard Institute of Economic Research found “no significant evidence of stock-picking ability.”

By chance alone, some analysts and mutual funds will always exhibit impressive patterns of success. And though many studies show that these past market successes are not good indicators of future success – that is, that the successes were largely just luck most people feel that the recommendations of their stockbrokers or the expertise of those running mutual funds are worth paying for. Many people, even intelligent investors, therefore buy funds that charge exorbitant management fees.

Full Disclaimer: I am not a financial planner. The views expressed in this post are all mine and they may or may not suit your needs. Please do you own due diligence. I do not make money on any of the products suggested in this post. 


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