Editor’s note: This article was first published in July 2011, so the research it describes as “a few months ago”, using Twitter to predict share price moves, refers to that period; Twitter has since been renamed X.
So far, no chess player has managed to beat a computer, because the computer has already calculated every possible move, which means the game is over before it begins. The aim is to mechanize investing, to the point that there are already sophisticated investment programs that detect a market trend within seconds of it starting and immediately send out a recommendation to buy or sell a stock. These programs work, but for some reason, as we have discussed before, people who play at trading regularly end up losing (with the odd exception).
Investing is a simpler game than chess, but at the same time it is much more complex, given that there are investors who have beaten the machine year after year. In investing, the brain has something a computer will never have: two eyes to read the financial news, two ears to hear about events that could change the direction of the market and, most importantly, the ability to learn and common sense.
Old-school investors admit that they have rarely analyzed a stock chart, although they have spent hours analyzing companies’ accounts.
The mechanized method of investing through software tends to recommend buying a stock when it has started an upward run or when it has been falling for a while.
As for buying a stock while it is falling, the old school of investing usually says that it is as risky as trying to catch a falling knife.
Now young graduates fresh out of university are questioning the investment method of history’s great investors, such as Graham, Buffett or Lynch. “Their method is outdated; it’s no use to a small investor.” Some of them forget that this investment method is the one those investors used to go from being small savers to great investors, so it was a thoroughly profitable method for them.
It reminds me of what happens when a son inherits his father’s company. “Dad, you don’t understand this stuff, you’re out of date.” And within two years the son has wrecked the company his father ran for 30 years (more knowledge, more ego, but less experience on the battlefield).
There are some things in life that will keep being done the same way no matter how much time goes by, and among them are sex and investing. New positions may appear (new investment vehicles), but in the end it all comes down to the same thing, the return (the orgasm), and just as with the orgasm, sometimes the return… doesn’t come either, because we got the method wrong.
New investors love forex (currencies), futures, investment funds and all kinds of stock market derivatives. The old guard don’t like these products, because they know that, at the end of the day, most of them depend on the same market.
Benjamin Graham argued that in bad times, when the stock market was difficult, it was all about diversifying your investments and looking for other markets. If Wall Street was weak, he looked to the London or Tokyo stock exchanges. If a country is going through a temporary economic problem, we will analyze it the same way we would a stock and invest in its bonds and debentures (government debt) or in corporate debt, since at those times they usually pay high returns, as long as you trust that the economy will recover in the long run. And let’s not forget emerging countries. That is the only way, and the only secret, to keeping a high average annual return.
Being an investor is a state of mind that sets you apart from the speculator.
According to Graham, I am not an investor, and to be honest, he is right. As soon as I see a high return I don’t think twice, and I don’t hesitate to sell the shares at a profit. It’s true that this is speculation, because you are not creating value in the company; you are taking advantage of it.
Being an investor means becoming part of a company you believe in, being one of its shareholders and helping to make the decisions that will shape its future. Being an investor means being a partner in a company whose shares you can pass on to your descendants as your inheritance.
Perhaps this is the part of the method that doesn’t work for small investors, because an investor without much capital doesn’t like the idea of tying up their money for 10 years. They would rather make lots of trades and get quicker profits. This is where the “dinosaurs” of investing warn us, because according to them…
“If you choose the right stock, one you have studied carefully, you have chosen a company with prospects, with a good manager, that is winning new markets and pays good dividends, then tying up your money in that kind of company will be one of the most profitable investments you can make. If you flit from flower to flower ever more eagerly, sooner or later overconfidence will make you land on a poisonous one.”
It’s sound advice, although I would add one condition: invest 70% of the money you have available for investing in that company, and use the other 30% for clear investment opportunities, because there are some.
Investing means using your brain.
Another thing a computer program can’t do is work out what thousands of investors will do in a given situation. You can. To know that, it is vital to study what kind of shareholders the company has. A company whose shares are 98% held by small investors doesn’t move on the stock market in the same way as one where a single person or entity holds 90% of the shares. If that person or entity decided to sell, the stock would hit the floor within seconds.
A few months ago it was reported that some students were predicting share price movements using an algorithm based on Twitter. The algorithm measured how many times a company was mentioned on the network, so the method worked as long as the news was about new acquisitions, purchases or moves into other markets. Because, quite obviously, if an airline becomes a trending topic because of a plane crash, I don’t think its share price will go up; quite the opposite.
Still, the algorithm these students designed makes sense: just like a singer, the more often a company appears on TV, the more records it sells.
If you did your homework when choosing your investment, by the time the algorithm spots the company whose value is about to soar, you should already be in.
Buffett is a great investor because, as he says himself, he is a good investor because he understands business. That is why he can spot an undervalued company with room to grow, which, again, is something a machine can’t do. Choosing a company that has just started out and recognizing that it will succeed because it is in the right market isn’t a matter of understanding finance; it’s a matter of understanding the consumer’s mindset and where the market is heading.
In short: using your brain for investing means knowing how consumers and other investors think. Investing is a competition, and at the end of the tournament the smartest player wins. So far, the masters’ investment method has beaten the traders, the machines and the markets themselves.
That’s why, whenever someone asks me to recommend a book for understanding investing, I always recommend The Intelligent Investor by Benjamin Graham. It’s old, but just as ancient Eastern sex therapies are now in fashion, Graham will give you the secrets to some very good “stock market orgasms”.
“One day, computer programs will buy and sell stocks for us. They will be so smart that, with no human intervention, they will deliver big profits to investors. When that day comes, anyone who uses natural rather than artificial intelligence will be rolling in gold.”
Further reading
- Why Warren Buffett doesn’t invest in tech companies but does in Coca-Cola
- Warren Buffett quotes
- An introduction to investing in the stock market
Featured image: Anton Chiang from Cupertino, CA, USA, CC BY 2.0, via Wikimedia Commons.
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