Part II: How the Pros Play the Biggest Game in Town

Technical Analysis

Study past price movements and trading volume of trading to to predict when to buy/sell a stock. Based on the castle-in-the-air view of stock pricing.

Is There Momentum in the Stock Market?

Past stock prices cannot be used reliably to foretell future movements. Furthermore, transactions costs and taxes make it hard to exploit any short-term momentum.

Flip a fair coin many times. Sequences of heads (or tails) and jumbled up sequences occur with equal probability.

Just What Exactly is a Random Walk?

In a random walk, knowing all prior moves is no help in predicting the next move.

Fundamentalists tout past earnings growth as a most reliable indicator of future growth. But academics have shown that past earnings growth are no help in predicting future growth.

Why is the Crystal Ball So Clouded?

• Many of the influential changes that affect earnings prospects are unpredictable.
• Creative accounting procedures produce dubious reported earnings, e.g. pro forma earnings, pushing due payments to future years, etc.
• Analysts may make errors, e.g. over-estimating the market size. Analysts also tend to copy each others’ forecasts.
• The best analysts go to the sales desk or to hedge funds.
• With discount brokerage firms and competitive commissions, analysts’ main buck comes from new issues and trading profits. Analysts don’t want to piss off the companies that they cover.

Do Security Analysts Pick Winners? The Performance of the Mutual Funds

From 1992 to 2017, the S&P 500 has had 9.69% while the average equity fund has had 8.55%.