Heads I Buy……

This study must have been done when “W” was at Yale. It is hard to believe that Yalies would think that they could predict coin tosses.
It is a stark example of overconfidence. As to the markets, there is the famous book A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing (Revised and Updated) by Burton Malkiel which makes the case that prices are random and therefore unforecastable. In fact, there is evidence that prices can be forecast. See McKinley and Lo A Non-Random Walk Down Wall Street more on this later.

From Adam Warner at Daily Options Report:

One of the many complaints we have with CNBC is the misleading Causality Chain. The incredible desire to simplify every market tweak into 2 or 3 sound bite “reasons”. Is this such a big deal though? I mean anyone playing this game long enough would see right through it and realize it’s just never that simple and behave accordingly. Or would they? Interesting article here on The Frontal Cortex (hat tip Abnormal).

…….In one classic 1975 study led by Ellen Langer, male undergrads at Yale were asked to predict the results of coin tosses, a cliched example of a random event. Nevertheless, a significant number of the men believed that their performance improved through practice – they got better at calling heads or tails – and that distraction would detract from their performance. How did they justify this wishful thinking? As Langer notes, the men engaged in some sly cognitive filtering and consistently “overremembered past successes”.

Is Wall Street any different? The market, after all, is a classic example of a “random walk,” since the past movement of any particular stock cannot be used to predict its future movement. Given this inherent stochasticity, it’s silly to attempt to explain the daily movement of the market: such an endeavor is like analyzing a series of flipped coins, or trying to explain the payout patterns of a slot machine. We can construct theories – and some of these theories might even sound intelligent – but they’re ultimately futile attempts to stave off the flux.

What’s even more disturbing is that such errant explanations might actually cost us money, since they lead, inevitably, to over-confidence. (Those Yale undergrads vastly overestimated their ability to predict coin flips.) We become so convinced that the logical-sounding explanations are true that we forget we’re dealing with a random, inherently unpredictable system. The end result is too much trading.

Well some would disagree that past movement can not predict future movement. I mean there are certainly some sharp technicians around. But I think it’s more about knowing that….you really don’t know. A good techie will deal in probabilities, know he’s going to be wrong a certain percentage of the time, set stops and targets, et. al. The media (and it’s not fair just to blame CNBC for this) offers what sounds more like guarantees. Event A causes Stock Movement B.

The author throws in an interesting study. A group is divided into two parts. One subset invests with absolutely no information behind prices. The other group has full access to all news. The “news” group outsmarts themselves and returns only half the other group.

Now in real life it’s hard to imagine that less (knowledge) equals more. It’s really about knowing how to process that information. And the media just gives all the wrong lessons on that.