(Part 5 of ten-part series on Financial Truths)

Section 1: The Efficient Market Hypothesis

Section 2: Who Is Your Competition?

Section 3: What Is Your Edge?

Section 4: The Wrong Ways to Use Technical Analysis

Section 5: Certainty vs. Probability

Section 6: The Winning Way = Big-Picture View + Timing Tools

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Section 1: The Efficient Market Hypothesis

  • Definition and forms: Weak-form, Semistrong-form, Strong-form
  • Why the efficient market hypothesis does NOT hold in the real world

Section 2: Who Is Your Competition?

  • The vast majority of shares are held by institutions or individuals who cannot or do not transact frequently
  • Paper by Edward Wolff of NYU – chart on top of page 15
  • Active vs Passive: Approx. 2/3 of US equity fund assets are classified as “actively managed”, 1/3 passive – statistic from Bloomberg article – but are they really “active?”
  • Who’s actually trading, reacting to new information that should affect prices?

Section 3: What Is Your Edge?

Section 4: The Wrong Ways to Use Technical Analysis

  • Ignoring one or more of the dimensions: Price, Pattern, Momentum, and Time (credit to Robert Miner – I recommend his book)
  • Magic indicators
    • Overbought and oversold indicators ARE NOT trading signals
    • Trading on momentum signals (e.g. Stochastic or MACD crossovers) by themselves will generate losses
    • “Bearish crossovers” marked by red lines would have produced large losses and significant trading costs, if used as signals to go short.

  • Trend-following: generates huge losses at major highs and lows, and repeated small losses in choppy markets
    • A simple method of trading moving average crossovers (20-day over 50-day) produced 6 wins, 11 losses, and lots of trading costs. Awful!

  • Failing to make a trading plan
  • Failing to make a risk management plan or to adhere to your plan
  • Ignoring trading costs and the cost of leverage

Section 5: Certainty Vs. Probability

  • You can never know for certain what the market will do
  • Technical analysis, when used correctly, identifies high-probability zones

Section 6: The Winning Way = Big-Picture View + Timing Tools

 

Intro music by audionautix.com

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