Not so random walk down the Wall St.

There are golden rules on investing:

  • Allocate your assets:
    Divide your investment into piles that have different risk and reward structure: real estate, cash, equity, insurance, etc. Think of their relative proportions and keep them.
  • Diversify:
    Within each pile, have enough diversification to cancel out the volatility. This is the proven way to get return without the risks. You can go to extreme with this and just buy Index Funds, or you can do your own mix.
  • Cover your risks:
    If you buy a stock, you can, at the same time, buy a put option. If the stock goes up, you make less money since you need to subtract the cost of the option. If the stock falls, however, you lose less since the option protects you.

There is only one problem: investment strategies are self-defeating. If there is a proven sure way to win, everyone will do it. Since all transactions must have a buyer and a seller, someone must lose. The winning strategy, therefore, will cease to work. All three methods mentioned above have been practiced by millions of investors. They just differ by details. If you follow these strategies, you will get exactly what everyone else’s getting: the natural return of the market. This is the foundation of the efficient market theory: that the market price has reflected all relevant information already, there is no one any investor can beat the market consistently. Those did were just lucky.

Many, including Warren Buffet, disagreed. They claimed that although the market is quite efficient that average investors cannot beat it, but they possess certain strategies that did and will continue to do so. Naturally, they cannot divulge such strategies. If you park your money with them, you shall be rewarded. Just look, those who did were. Handsomely too.

Then came Enron, Bernie Madoff, and other crooks that simply used the shroud of secrecy to steal people’s money.

Sebastian Mallary’s book revealed those secrets. Of course, the very fact that he was able to do so mean they are no longer useful. He was able to reveal only after those hedge funds have failed; either by too many learned and copied their secrets or by the market closing down the arbitrage they were exploiting. (The chapter on Soros destroying foreign governments with money was scary.)

I believe the market is efficient enough to punish those who do not do their homework. Any reasonably intelligent investor can beat the market if he or she is willing to do the hard works for tracking trends and studying the fundamentals. It is definitely possible to win, just takes disciplines and strong nerves.

Kind of like life itself. Isn’t it?

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