Markets are tough to beat. In order to do so, you must have better information faster than others. That is difficult to achieve and then translate into profitable trades. Hard data do not provide such advantages unless you are an insider and that makes it illegal for you to use the data. You must anticipate what hard data will be in the future, before others receive it.
The following describes a recent example.
I was out of town last week on a golf trip when the first Obama-Romney debate took place. On Wednesday morning (the debate was that evening), I investigated InTrade, basically a betting site where you can trade shares of Obama or Romney. If one wins you get a $10.00 per share. The loser gets $0.00. Obama was a prohibitive favorite. If I recall, shares of Obama cost about $7.50 versus Romney around $2.50. I thought that Romney would win the debate and his shares would appreciate in this “market.”
My judgment was correct but I had no account with InTrade and was too busy to figure out how to go about setting one up. It was easy to rationalize against doing so because InTrade in the last several years has not been as good a predictor as it once was. It is a thin market and easily manipulated. It also has higher transaction costs than financial markets, another area I was not interested in learning more about. I also had a tee time that I had to make.
I think his shares gained 8% after the debate that evening. Today, at 1:20, the value of the shares on InTrade is Obama $6.30 and Romney $3.73. Percentage-wise, buying Romney would have been a nice trade.
Monday of this week I published an article regarding the debate outcome and concluded that Obama would also lose all three debates. Convinced he could not be re-elected under these circumstances and also that the polls were understating Obama’s problems, I began to think again whether my expectation could be exploited in financial markets. I thought of the coal industry, one that Obama has pledged to destroy. If he is not re-elected this industry will recover strongly.
I committed funds to Arch Coal, a company that had been slaughtered in financial markets. Arch was an easy pick. In late 2008, ACI was at $45.00 per share. It actually rose to as high as $77 during the first half of Obama’s first year in office and then plummeted to $13 in the next six months. The graph of the stock is below:
Is this stock broken? Can it recover? I don’t know, I really didn’t do any fundamental research on the company. I do know that the coal industry will do much better under Romney than under Obama and this stock should benefit.
I expect Romney to win and I expect other investors to increasingly realize that as we get closer to the election. I began taking positions in ACI Monday and yesterday. These positions included shares and call options. On this trade, I got lucky and had over 50% profit today when I closed out the options positions. I still hold the shares. Will they continue to go up? I don’t know, but I like the odds of that happening.
This is not a recommendation regarding this stock! The point is to illustrate how analysis can allow you to move ahead of other investors or traders. This trade worked. That is not always the case.
There may be other vehicles to exploit what appears to be the expectation that Obama will be re-elected. Will I stay with this stock? Probably for a while, but with stops to protect most of my profit.
Will I add more options or shares in the future. That depends on how I evaluate the gap between perceptions of the outcome of the election and what I perceive it to be. With the VP debate tonight and an expectation that Ryan will outshine Biden, I might consider adding to the position before this day ends, depending upon what the stock does this afternoon.
HappyinHowell: 
Mr Misno: 
Marsha: 
Brian Wilson: 
Steve: 
Larry Crouse: 
Brian Wilson: 
Monty Pelerin: 
Bob Snyder: 
Syrin: 
If it is not to much trouble, I would like to know more about your background re: your study & knowledge of stock trading systems.
Many thanks,
Steve Foster
Steve,
You can see my background on the About page. Regarding trading, my sole source of income for most of the last twenty years has been from investing/trading. I have used most of the software packages including TradeStation, Omnitrader, TC2000, MetaStock and a few others. I have taught Investing classes in college and at the graduate level. I have also taught technical analysis classes, although not in college.
For a few years I wrote my own systems and traded via technical analysis. After much effort, I concluded that “systems” per se, while they may have some worth, are not worth the trouble to create and maintain them. For technical analysis today I utilize a handful of indicators to time entry-exit points. Primarily my investing/trading is dictated by fundamental analysis based on expected economic and political decisions. Brokerage firms supply all that I need for my indicators, although I still utilize TC200 out of habit and convenience. I utilize its indicators and especially its screening capabilities.
I am toying with the idea of an investment site, although am still working on the details and feasibility.
Please note that this is not the first time I’ve commented on “market efficiency” (i.e., with respect to the political betting market makers like Intrade) on this website. Firstly, by the standard textbook definition of “market efficiency” (from Investopedia.com): “formulated by Eugene Fama in 1970, suggests that at any given time, prices fully reflect all available information on a particular stock and/or market.” It is a fact, and not my opinion, that they generally do not. Thus, the definition is information centric, yet we know that humans, to be blunt, suck at incorporating information into prices. A classic example of this is “earnings drift”. In “earnings drift” it takes, on average, about nine months for most of the content of earnings announcements to get embedded into stock pricing (and by that time, by the way, another one or two announcements have been made). Unfortunately for information centric market efficiency, by definition, the information is supposed to not just happen on the day of announcement, but be instantaneous. I could give many other examples where publically available information like earnings announcements doesn’t get incorporated into pricing as market efficiency would suggest. The key is to keep in mind is that it is centered on information and humans have been well documented to be biased and downright bad at incorporating information into financial markets prices or valuations. Now given that earnings are arguably the most researched and publically reported on pieces of financial information and they systematically do not show evidence of getting incorporated into pricing as market efficiency would suggest, I ask you: What are the odds that more obscure and much more biased information is incorporated into pricing of something like, for example, who is going to win the election months or weeks before the election is held? Answer: We are fast approaching the number and probability zero.
For my money, the main issue with information centric “market efficiency” these days is that it has become a kind of quasi-religion for many business schools and academics. In fact there was a survey done around 1999 and published around 2000 (Welch in 2000 I think) where it was revealed that the average finance professor essentially thought one thing yet taught something else. Long story short, just because the markets are not information “efficient” it does not mean you can profit from this, and even your professor thinks this but doesn’t necessarily teach it as market efficiency is the accepted paradigm. As pointed out in the piece, transactions costs and other real limits to arbitrage exist. For example, during the Dot.com bubble (bubbles, by the way and by definition, cannot exist in the land of information centric market efficiency), one company called Palm was being “carved out” by its parent called 3M (about 5% of the equity was publically being offered in an IPO). The revealed (i.e., by the IPO) market value of Palm was so high that it implied that the value of all of 3M’s other businesses was around -25 billion. That’s right, negative! In short, the market couldn’t add or subtract values. The logical arbitrage was to short Palm and go long 3M (therefore, you had at a minimum a ‘free lunch’ of $25 billion), the problem with that logical trade was that you couldn’t physically pull it off. There were only 5% of Palm’s shares available (the rest was held by the parent), and most of that 5% was held by …, drum roll …, Wall Street underwriters. In short, and pun intended, you couldn’t short. In effect, just one limit to arbitrage, in this case short sales constraints, stopped you cold. The price was wrong yet you couldn’t profit from it (i.e., you couldn’t eat the ‘free lunch’ as it was in theory there, but in practice uneatable). In fact, there are many cases as absurd or more absurd, but you get the idea. I can’t tell you how many people still parrot the canard about being rich if the markets are inefficient. Again, In fact, and based on logic there is no a priori reason to think you can make money based on information that isn’t being properly (i.e., according to the theory) incorporated into financial market pricing, minimally due to limits to arbitrage.
Which brings me to Intrade and Monty’s comment on not being able, or possibly willing, to profit from the discrepancy between his information and/or analysis and the Intrade “markets’”, there is no a priori reason for me to think that the Intrade market for the US presidential election is “efficient” in theory or practice. If the market for “liquid” large cap US stocks cannot get it right in an information efficiency sense, why would we think Intrade’s rather shallow and sometimes seemingly manipulated markets would? Furthermore, Intrade, like any market as the truth becomes clearer, will be increasing forced to converge to reality as the election approaches (i.e., otherwise the size of the loss by those holding the price/probability of their favored candidate up will more and more likely wipe them out, and it will become clear to even a fool at that point); but because the media is so very biased it is difficult for your average Intrade investor/bettor to act according to pure market logic up until the last minute. Thus, there is a tension in politics you might not see as clearly in more purely economic markets between the political “hope” of the anointed media darling/cultural Marxist scum and the economic “fear” of losing real wealth in a trade that was biased from the start. Anyway, as it was some months ago, my rough guess based on the effects of media bias is that the rough Intrade odds are still skewed about 10-15% toward the usurping un-American cultural Marxist scum candidate for president. How’s that for unbiased analysis?