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DanielLC comments on Rationality Quotes June 2014 - Less Wrong
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As somewhat of a libertarian, I tend to fall into that last group. I have to keep reminding myself that if nobody could outguess the market, then there'd be no money in trying to outguess the market, so only fools would enter it, and it would be easy to outguess.
There is the old joke about a student and a professor of economics walking on campus. The student notices a $20 bill lying on the sidewalk and starts to pick it up when the professor stops him. "Don't bother," the professor says, "it's fake. If it were real someone already would have picked it up".
That joke got less funny the first time I picked up a Christian tract disguised as a $20 bill. It got a lot less funny the second.
But it's an equilibrium, right? Lumifer's joke may be funny, but as an empirical matter, you don't see a lot of $20 bills lying on the ground. There's no easy pickings to be had in that manner. So the only people who can "outguess" the market (and I think that framing is seriously misleading, but let's put that aside for now) are individuals and organizations with hard-to-reproduce advantages in doing so - in the same way that Microsoft is profitable, but it doesn't follow that just anyone can make a profit through an arbitrage of buying developer time and selling software.
Whether it's worth picking up a $20 bill depends on
The odds for #2 and #3 are pretty high compared to the odds of similar activities when playing the market. The odds of #1 vary depending on how well travelled the place is but are generally a lot higher than for whether you're the first person to notice an opportunity in the market.
Of course, #1 is also affected by how many people use this entire chain of reasoning and conclude it;'s not worth picking up the bill, but the other factors are so important that this hardly matters.
The way I see it, in practical terms, it's always worth picking up. I've picked up a number of fake bills. I keep them. It's better than leaving them to torment each successive person who picks it up until someone else does it instead.
No, why would it be?
Equilibrium is a convenient mapping tool that lets you assume away a lot of difficult issues. Reality is not in equilibrium.
Because when it's easy to outguess the market, the people who are good at it get richer and invest more money in it until it gets hard again.
It's not in perfect equilibrium constantly. I've heard of someone working out some new method that made it easy which took off over the course of a few years until enough people used it that outguessing the market was hard again.
This is an extremely impoverished framework for thinking about financial markets.
Let's introduce uncertainty. Can Alice outguess the market? Um, I don't know. And you don't know. And Alice doesn't know. All people involved can have opinions and guesses, but no one knows.
Okay then, so let's move into the realm of random variables and probability distributions. Say, Alice has come up with strategy Z. What's the expected return of implementing strategy Z? Well, it's a probability distribution conditional on great many things. We have to make estimates, likely not very precise estimates.
Alice, of course, can empirically test her strategy Z. But there is a catch -- testing strategies can be costly. It can be costly in terms of real money, opportunity costs, time, etc.
Moreover, the world is not stationary so even if strategy Z made money this year whether it will make money next year is still a random variable, the distribution parameters of which you can estimate only so well.
It's good enough.
Knowing about things like risk will tell you about the costs and benefits with higher precision. It will explain somewhat why there's lots of people involved in a market, and not just a couple of people that control the entire thing and work out the prices using other methods.
All that uncertainty makes the market difficult to predict. But all you really need to know is that regardless of how easy or hard it is to guess how a business will do, the market will ensure that you're competing with other people who are really good at that sort of thing, and outguessing them is hard.
No, I don't think so.
This can be applied to anything from looking for a job to dating.
So, no, that's not all you really need to know.
You wouldn't expect to be able to do job X better than a professional if you don't have any training, would you?
Also, economists say the same about the job market. If you don't have any particular advantage for any given job, you can't easily beat the market and make more money by picking a high-paying job. If a job made more money without some kind of cost attached, people would keep going into it until it stops working.
I guess there is more to the market. It's something that scales well, so doing it on a small scale is especially bad. It takes exactly as much work to by $100 in stocks as $10,000. If you're dealing with tiny companies where someone trying to make trades on that scale would mess around with the price of the stock, that won't apply, but in general trying to make money on small investments would be like playing poker against someone who normally plays high stakes. They're the ones good enough to make huge amounts of money. The market won't support many of them, so they must be good.
I have a weird feeling that a bunch of people on LW have decided that there's nothing to be done in financial markets (except invest in index funds), fully committed to this belief, and actively resist any attempts to think about it... :-/
Isn't this optimal? The case for index funds by ordinary investors is extremely strong, and if there exists good evidence to the contrary it will be of the form that is almost certainly beyond the ability of most LW people to properly evaluate.
I tend to think that the current markets are efficient enough that putting my money in index funds is about the best I can do from a time/opportunity cost perspective.
The professionals I know working for hedge funds do routinely find small inefficiencies, but in order to make them profitable enough to be worth the time investment, they generally have to exploit quantities of leverage I don't have access to as an individual.
If you enjoy pouring over the market looking for details to exploit, then it can be a use of leisure time I guess. I pour over enough data at work that spending free time pouring over more in order to achieve fairly small gain just doesn't seem worth it.
On the contrary, there are very many profitable software companies of all sizes. Writing software is a huge market that has grown very quickly and still provides large profit margins to many companies.
You might make an argument that Microsoft's real advantage is the customer lock-in they achieve through control of a huge installed base of software and files. Even there there are many software companies in the same position. It's hard to reproduce the advantage of having a large share of a large market. But that doesn't necessarily make it unprofitable to acquire even a small share of the market.
I think you misunderstand my point. Of course there are many profitable software companies (I work for one of them!), in the same way that there are also many banks, hedge funds, etc. But all of these have hard-to-reproduce advantages ("moats" in the lingo). The reason Microsoft (or any other software company) is able to buy developer time and sell software at a profit is because they have social and organisational capital, because they have synergy between that capital and their intellectual property rights, because they have customer relationships, etc etc. It is not an arbitrage and it's not true that just anyone can do it. Microsoft themselves are in fact a fine example of this; throwing resources in the fight against Google has not proven successful.
Yeah, but it's an equilibrium that it's really hard to outguess the market, not impossible.
There is a great deal of money to be made by entering the market and not trying to outguess it. This is what index funds are about. Thus many non-fools enter the market.
By "enter", I meant try to outguess.
If everyone bought stocks randomly, it would be easy to outguess.
A lot of the thread descending from here is covered by the whole of the quoted essay. I'd quote more, but I don't want to make it easy for people to just read another quote.