A seemingly doomed games retailer sees its shares rise 20-fold and makes headlines around the world on the back of some ramping on Reddit.
A defunct cryptocurrency that’s a joke about a dog is apparently worth more than most of the UK stock market.
In such an era like this, I expect making the argument the markets are efficient will get especially short shrift.
But let me ask you something…
Did you get rich off either of these incidents?
Are you invested in Jim Simon’s Medallion fund? Do you work at Citadel or Goldman Sachs?
No?
Then markets are efficient for you.
Ain’t no such thing as an easy edge
The Efficient Markets Hypothesis (EMH) states that asset prices reflect all publicly available information.
There are no obvious, easy trades. There’s no way to consistently beat the market. Active investing is pointless, there’s no free lunch, you don’t have an edge. Don’t even bother trying.
But how can this be true? There exist all sorts of super-investors, after all.
What about Warren Buffett?
Well, are you Warren Buffett?
No?
Then markets are efficient for you.
Most super-investors are only observed as such because of survivorship bias. We don’t talk about all those who lost along the way.
Where the pros find their investing edge
In my professional capacity I’ve witnessed actual edge, firsthand. And pretty much none of these edges are available to the private investor.
Let’s run through a few examples.
Cheating
A very long time ago, when I first worked in investment banking, our trading desk knew when the research department was going to upgrade a stock. We’d quietly accumulate it for a few days beforehand – by filling customer sales of our own book, but passing buys to the market.
On the morning of the upgrade, the sales gang would push the stock on our customers, and guess what? We had plenty of inventory to sell them!
Then there’s the euphemistically named ‘pre-hedging’ – aka front-running.
Customers selling a large block of stock? We’ll just sell a bit first. (This was what Bernie Madoff investors thought that he was doing – front-running his brokerage clients).
Trading against your own customers’ order-flow is also a good (although volatile) edge.
This is what a lot of retail FX / spreadbet-type brokers do. They literally take the other side of every customer’s trade. Your losses are their gains.
They then rig the game to make sure you lose, by, for example, giving you orders-of-magnitude more leverage than is appropriate for the volatility of the instrument being traded. This way you will keep getting ‘stopped out’.
Information
Do you have some price sensitive information that everyone else doesn’t?
Do you have the doctors involved in a drug trial on the payroll as – ahem – consultants?
That’s a real edge.
If it’s really price sensitive, you can’t act on it if you want to avoid prison.
For the avoidance of doubt, information you get by reading the business section of The Telegraph on a Saturday morning is not price sensitive information. Nor is a public RNS from the company, a tweet, a blog post, or something in a WhatsApp group.
I’ll save you a lot of time: any information you’ve got is not price sensitive.
Speed
Speed can be an edge. Maybe everyone gets the same information, but some get it quicker than others, or are able to trade more quickly.
Carrier pigeons from the battlefield or microwave towers to Chicago are all speed edges.
There’s no way you’ll ever be faster than the professionals.
Make your own investing edge
Some investors’ reputations precede them so much that they can make their own edge.
Warren Buffett is a textbook case. Once he has been initially successful in an area – perhaps by luck – anything he touches is gold.
Buffett used this to great effect with his Bank Of America loan and warrant deal in 2011. Once the market knew Buffett had its back, the bank was no longer in danger – and Buffett made out like a bandit.
Want to load up on some dodgy crypto before tweeting the whole world about it? Seems to work pretty well if you’re Elon Musk.
Unless you work for a shop that does this sort of thing, these edges are not available to you.
Don’t think that buying the shares in companies that do have these edges will help you. Such outfits are not run for the benefit of the shareholders.
Investing edge for the masses
There are a couple of edges that maybe – just maybe – available to private investors.
Size / Liquidity
You’ll often hear a claim that as a private investor you can invest in smaller, less liquid stocks than institutional investors. And that this can be an edge.
You’ll mostly hear this from people promoting those very same micro-crap (no, that’s not a typo) companies.
I’m not entirely convinced.
After all, if the company was any good, it’d have a higher market cap, right?
Risk
Now this one is interesting. You can just about construct an argument that this edge is available to you.
Maybe you’re prepared to take risks that others aren’t?
This is part of Roaring Kitty’s edge (that is, the r/WallStreetBets guy).
No sane person puts a decent fraction of their net worth in short-dated, far out-of-the-money call options in a near-bankrupt retailer.
But you can. If you want to.
Subtler than just taking more risk, you also choose to take different risks to professional investors.
ESG is a great example. Maybe the woke portfolio manager at Blackrock can’t take the career risk of stuffing her fund full of tobacco, oil, and slave labor garment manufacturing companies?
But you can.
Time
As a professional investor, you can only underperform the market for so long before they take the money away and give it to someone else.
As a private investor, it’s your money. You don’t have to explain yourself to anyone.
In theory this can be a powerful edge.
In practice it’s very psychologically difficult to stick with a losing strategy through very long, deep, drawdowns.
Inevitably you give up just before it starts working anyway.
Edge your bets
As a private investor you’ll rarely have an edge. So if you find yourself with a (legal) one, make the most of it!
I’ve been investing for 40 years, and in a personal capacity I’ve had an edge on four occasions.
Yes, you read that right. An average of once a decade.
Here’s a small one I can tell you about…
In 2012, our trading desk was across the way from the macro guys. Now you might not know any macro guys, but believe me, they are obsessed with interest rates. Really, really, obsessed with interest rates.
And who sets interest rates? Central banks do.
And who runs central banks? Central bankers do.
Macro guys would short a yard of Yen on the basis of a rumor about the sort of sushi a minor board member at the Bank of Japan had chosen for lunch.
So in late 2012 we’re expecting the announcement of a new Governor of the Bank of England. It seems to be all they can talk about.
I’m following along by keeping half an eye on the Betfair odds. Tucker and Turner are firm favorites, and then there are a few long-shot stub quotes, all at 100-1.
So on the day of the announcement I overhear one of the macro guys say: “That’s weird. Bank of Canada has a press conference at the same time as the announcement. Could it be Carney for governor?”
By the time he’s finished this sentence I’m on Betfair.
Carney’s still at 100-1!
True, this is not a dead-cert. But 100-1 is clearly now a mis-pricing. There it is – a market inefficiency right there in front of me.
Sadly, there’s only £100 of liquidity in this bet. It’s a £10,000 note lying on the pavement, just waiting for me to pick it up.
Naturally I lift it all.
But if they’d been £1,000, or £10,000, or even £100,000 of liquidity?
I would have done the lot, every single penny.
The rest of the time? Just index.
See more articles from Finumus on Monevator.
What a great article-frightens the life out of me as it should
Like many amateur investors I went through insurance companies ( high fees- poor performance),investment trusts( lower fees but gambling) to finally arrive at John Bogle,Vanguard and Index Trackers-whew!
Been in Global Equities/Bond Index Trackers for many years and they did the job for me
The comments on cheating,inside information (insider trading) ring very true as I continue to read and learn more about the finance
It’s a fierce predatory cheating lying financial world out there
No place for a minnow like me
I have observed from the index tracker side lines now for many years
This article confirms that I did the right thing (for me)
I only wish I had learnt all this sooner in my investment career
It’s great the investors now have this sort of info at the start of their investing careers-especially thanks to Monevator.com and similar websites
xxd09
For me, the most rewarding ‘edge’ or strategy these past couple of years has been to avoid fossil fuels and their backers and embrace the transition to the emerging net zero economy. So far, so good…the transition will no doubt speed up whilst of course, the edge will diminish and become mainstream.
Happy Earth Day!
Would agree with most of the article and like the interesting stories from the past. But the part about not taking notice of people promoting small micro-crap companies as you call them seems at odds with the blog post about making a million on Argo Blockchain shares (at a few pence at the time) after reading a post from someone basically promoting it on Twitter?
@diy investor, what you are describing is not an edge. You have made investments which have worked out. This is a common mistake to make. “I invested in shares, beat the market, so I must have an edge when it comes to investing in shares”. This does not follow.
Occasionally free lunches come along that do give retail investors an edge over the professionals and the market. 1980s privatisations are an example. The prices were set to almost guarantee successful flotations. From memory only one privatisation failed (BP?), but the likely failure was known about long before retail investors had to apply for shares. Allocations were often heavily scaled back and done in a manner favourable to private investors. Once you had the shares, the edge was gone and that was a good time to sell. Some privatisation shares no doubt did well if held for the longer term, but that is just how it worked out – no edge involved.
Building society demutulisations were another one. You just had to go round depositing £100 into building societies to become a member. The payoffs for those that demutulised were enormous for the risk and effort involved.
Retail FSCS protected or NS&I deposit accounts frequently provide an edge to retail investors. Higher rates are often available to retail investors than with equivalent investments in short dated gilts, enabling retail investors to beat the market.
Before the GFC it was possible to borrow cash on credit cards with zero interest and zero balance transfer fee. Again an anomaly available to retail investors that was not to institutions.
Markets are not super efficient of course. eg during the GFC I worked with someone who would regularly sell one Lloyds preference share and buy another identical in every way (bar the coupon) Lloyds preference share for an uplift in yield. Then a few weeks later he would flip back for another uplift in yield. Insane inefficiency considering the trading spread and stamp duty that had to be paid.
Having an edge tends to come at the price of effort. I can accept that a private investor might be able to gain an edge by personal in depth analysis of say particular niche smaller companies. But then you need to consider the value of the time spent in doing this.
Really enjoying your articles on here @finumus . Timely reminder to leave it all alone – the problem with ever improving platforms and apps – it’s all too easy to apply the edge you don’t have!
spelling again
What about Warren Buffett?
Well, are you Warren Buffet?
Another gem. Although “mico”-crap IS a typo!
If you’ve had 4 edges are you a parrelellagram?
Tax situation/craftiness can be an edge over the rest of the market I believe, and as you mentioned risk tolerance, since different people have different tolerances – flexability feeds into that.
humility is an edge, patience is an edge, correct grammar would probably also be an edge that I do not have lol.
Also going to the effort to learn about passive rather than being automatically put into an active pension fund by your employer is an edge agaist most of the population.
But theres also edges in being able to live on less, being able to spend what you do have, and being able to enjoy your retirement, and also being able to enjoy the job that gets you there.
Great article, thanks.
Great post. Agree with all this.
In a former life I was a financial futures trader for a big (at the time) Japanese bank .. now I buy VWRL and leave it alone.
The mere fact that people have different risk profiles means in a sense that equities have more value to some and bonds have more value to others – if you’re breaching the LTA then equities won’t be worth as much to you for example, whereas a young desperado has greater needs and more tolerace
(age is also an edge both ways – young have more time, old have more certainty)
But basically if the market is an average, then you simply have to genuinely be in a non average situation to pick up equity/bond index funds at a cheaper price to you than what they’re truely worth to you
i.e. You’d still invest if equities returned 3% p.a. because you have limited alternatives, you’d still buy bonds yielding -5% p.a. if you couldn’t get fscs protection on all your cash via banks and /or still believed in bonds as dry powder
I’ve not seen any writer on Monevator make the case that active investing is a bad idea in a long while
Excellent post, I agree with 98% of it. I do think the “Time” one is a genuine edge for the retail investor. Career risk means most professional asset managers are really investing over a 1-2 year timeframe, 3 years if they’re lucky. It also means that they are under huge pressure to follow the herd. Retail investors can allocate capital in a way that has a good chance (not a certainty) of working out over a longer time horizon even if we know it may not happen any time soon, and even if the allocation is very different from the global market (overweighting the UK market at a CAPE of 16 and underweighting the US market at a CAPE of 37, for instance).
There is a very common and rarely unquestioned narrative that retail investors will “inevitably” give up on these long term contrarian positions at some point. Depends on the investor – you have to know yourself – but I don’t agree that this is inevitable, any more than I agree with the related narrative that retail investors will usually panic sell in a downturn.
Hope you bought a pint for the macro guy!
I used to work at GS, does that count? lol
Actually, my investing edge is reading what my readers are saying when I write about various investment topics. I notice some trends that look interesting and do more research. Sometimes I make an investment b/c of all the datapoints.
More hedge funds and active fund managers should use data sourced from relatively large websites to find trends.
Sam
Interesting post and well made points.
@kall, I don’t rhink the message of this post at odds with F’s other post. I think he wanted quick and easy exposure to bitcoin as an asset class, a small percentage and as a diversifier. The gains were spectacular of course but he claimed no edge. It was about asset diversification and adding bitcoin in the mix I think.
Welcome to the murky world of edges!
In my limited experience there are many that like to blur the lines between what’s acceptable and what’s not. Insider trading is a whole topic which I see you’ve done well to stay away from in the article but could tick the boxes of cheating, speed and price sensitive information. I imagine many who work for listed companies, especially those around the c-suite or similar restricted individuals, at one time or another may have come across something which could be said to be an edge.
I would like to stake a claim on negative edge. The majority of my “smart bets” on “mispriced” “opportunities” sit in a pile of shame in my wife’s GIA.
If you want an edge, ask what I’m planning to buy, then short it.
Thankfully, the majority of our money is safe in VWRL which continues its inexorable march upwards.
Another great article from @Finumus!
Great post! I think an information edge could be a little more widespread than you might think, though. I’ve made a few punts based on what I understand of the tech industry (which is the area I work in), and while it might just be survivor bias (in the sense that I think it works because I’ve been lucky), they’ve all worked out well.
For clarity: every month I put money into my ISA, and normally I just whack it into my index funds. But every now and then (say, once a year or so) I get a strong feeling that a company isn’t showing the kind of price I’d expect from recent industry trends. These are usually not companies that are in the news but also aren’t small-caps (Cadence Design Systems has done pretty well for me, for example) but sometimes they’re bigger companies — I’ve made a good return on Nvidia from a 1k investment back in 2015.
Every one of these punts has doubled within a year or so, and in every case I sold half, put the cash into the index fund, and kept the rest. In some cases I sold more later on, or dumped the stock when I felt it had probably topped out. I’ve never bought a second tranche of any stock I’ve bought like that — too tempting to buy into the rise!
It could well just be that I’ve got lucky on the trades I’ve made so far — perhaps that’s the most likely explanation. And I’d never consider putting more than 1% of my total assets into a bet like that.
But if your job puts you in a position where you get information on trends in an industry before the investment bank researchers are likely to hear about it, and make sure that you’re buying shares in the people selling shovels rather than the gold miners, then I think it’s worth taking a few punts and, after a few, calibrating whether you’re right or not. So long as it’s not your focus.
@MRW – fair point about the reason for buying for diversification into Bitcoin/crypto and it makes sense within that blog post and yes its mentioned not to invest after 2 minutes on Twitter
But its this article that warns about people promoting micro crap and not being convinced about the merits thereof which i guess is meant to cover all forms of investing including diversification assets i.e Dogecoin mentioned at the start
But i found the difference (which might only be me splitting hairs) interesting rather then troubling
I don’t believe I have an edge. I’m very taken by Lars Kroijer’s gilts-plus global-tracker strategy and I think I will find it liberating.
But although I have sold a lot of funds in order to implement Lars, I just can’t bring myself to sink large sums into a global tracker right now. There must be a correction coming ….
So I DO think I have an edge 🙂
Yours, mired in uncertainty
N
If investors were perfectly rational and markets perfectly efficient, finding an edge would be impossible. Fortunately, human emotion messes up the picture. You can find an edge if you wait for the moment of maximum hysteria and go the opposite way to everyone else. You can also combine this technique with index investing.
Like many on here, im 95% invested in index funds and mainly a global tracker. Though, through friends about 18 months ago, one of whom worked on the Oxford vaccine I came to hear about Moderna. A little bit of digging and I added it to my watch list. I invested in it about 12 months ago and is up about 120% to date, but up 450% since I added it to my watch list…
Nice article.
I was amused by your bet on the Carney appointment.
I’d have definitely gone with the £100 bet. But £100,000 on something that isn’t a ‘dead-cert’!!! I’m guessing you’re considerably richer than me 🙂
This misses a key attribute: segmentation. Even assuming markets are efficient (the’re not but it’s a decent approximation), that efficiency will be defined vs. the average marginal agent.
But agents are not homogeneous in most markets. Their aims/objectives are different. Their restrictions are different. Some are investors/speculators looking to make a return, others are hedgers looking to reduce risk. Index investors follow arbitrary rules that are clearly not efficient. A leveraged investor will see things differently to an unlevered one. The market, as a whole, can be efficient, but it may not be efficient for any specific agent.
Equity markets are unusual because agents are more homogeneous than typical. They nearly all are economic agents wanting to make an investment return. Take FX markets as a counter example. Over the past 30 years, active currency overlay managers have been able to generate excess returns net of fees. Not huge excess returns but an information ratio of around 0.5 (50bps of return for every 100bp of active risk). Most of that return, in a perfect zero net sum game, is coming from the activities of a significant number of non-economic agents (currency reserve managers, corporate hedgers etc). Those non-economic agents are simply not bothered they are losing money as their objectives are completely different.
Don’t always extrapolate from equity or bond markets. They are rather small markets compared to the much bigger interest rate and FX markets. For example, Bluecrest didn’t make returns of 50%, 54%, 25%, 50% and 95% between 2016 and 2020 only because they have better analytics/information/speed. Those factors enhance returns but it’s their ability to exploit segmentation in the swap yield curve that sits are the heart of their performance.
On two occasions in my career have I ever had a “possible” edge similar to what you describe:
A few years back I was working on an oil platform trouble-shooting a piece of equipment with another engineer. His company was performing the well test on a neighbouring rig for a small operator. This was their only prospect. The test on this well was the culmination of several years work and was highly price sensitive – proper make or break stuff.
One morning he was chatting his colleague on the neighbouring rig through facebook messenger. The rig owners had cut telephone and internet on the rig to avoid news leak but his container had a satellite link so that the onshore teams in Aberdeen and Houston could monitor the data real-time from the well.
I asked casually how the well was doing. He asked and relayed the response.
He told me it was producing roughly twice the mid-case estimate. Dry oil, no water, no H2S. In short – it was an absolute peach. I toyed with the moral and ethical consequences of acting on this information for at least seven seconds and made a decision.
2 hrs later they announced. Price jumped 40%.
An excellent article, written in an entertaining style.
I probably don’t have an edge, most of the time I know I haven’t.
But very occasionally I struggle to see the market behaviour as rational… these rare occurrences allows trades that make money.
Every FINUMUS post always makes me feel like I’m getting a glimpse into another slightly magical world. I’ve not had a edge in investing, but there have been times in my professional career and adjacent spin-offs. For example, I spotted the potential in facebook advertising, Amazon Kindle and SEO early and did well out of them.
What does FINUMUS mean, please?
There is surely nothing wrong with taking a punt now and again on knowledge gained by observation etc in the market place
Many have advised having a “play portfolio” of a few thousands alongside their Savings portfolio-as a safety valve?
A “play portfolio “ could be justified in the case of a keen young investor as a learning experience
For older investors as fun!
But it is not the game to play with your pensions and savings-the risks of failure and the very serious consequences for most investors is too great
In most cases the ups and downs of the” play portfolio “will justify/reinforce the Investment Plan adopted by the Investor for the major part of his/hers savings -keeping the investors “nose to the groundstone” of saving as much money as you can,using global index trackers and living frugally as the only guaranteed winning games in town for a successful retirement!
xxd09
@kall
About Argo Blockchain – I didn’t have an edge – I was gambling.
@Matthew
“The mere fact that people have different risk profiles means in a sense that equities have more value to some and bonds have more value to others” – I kind of agree…. the market portfolio is the portfolio that everyone should hold. If you want more or less risk you should hold more or less cash or leverage. In theory…. however in reality we can’t all borrow at the risk-free-rate, and tax shelters are sort of an edge.
@Ben Morgan
“You can find an edge if you wait for the moment of maximum hysteria and go the opposite way to everyone else” – Because that’s worked in the past? Yes, it has… mostly. But survivor-ship bias?…. If you’d gone all in on Russian stocks on the eve of the revolution, you might not feel that way.
@ZXSpectrum48k
Your idea that there are non-profit maximizing agents in some markets, specifically FX. I love this idea, and I’ve told a room full of institutional investors it’s a reason that a fund I ran had alpha. But…. are they really big enough to swamp the marginal arbitrageur? Maybe… but I’m actually less convinced of this argument than I was when my salary depended on it 🙂
Verifyable edges exist in sports betting ALL the time. Most of the time is a negative edge (overround) in favour of the bookie, but with a small bit of maths if you know how to price up a horse race and you know how to exploit the fixed fractional payouts on Each-way bets then you can find massive underrounds to exploit nearly each day. You don’t really even need to know anything about horse racing, you just need to understand payout structure and some intermediate level maths.
Time and buy and hold is my investing edge.
There is something about the way these meme stock/crypto fortunes have been made that seems so easy, even if it’s people being right for the wrong reasons (or not even knowing why they’re right). In reality, there are far fewer people actually getting rich off this stuff than it seems.
I wish I had the risk tolerance of Roaring Kitty, what a legend. I went back and watched his initial four hour Youtube video when GME was at a few bucks a share and he was very level headed about it being a little out there. Good for him, but mostly back to the index for me.
Do I have a *consistent* edge? Of course not. Might I have an edge in a given time and circumstance that could matter? If a once in a lifetime chance comes up, probably better take it. If my NW is 80 times my income and I’m not yet 60, and inherited nothing, I guess I must have had an edge. Of course luck is always a factor to some degree. But to those who’d claim such things are nothing but luck, you know what Keynes said: “It’s better for the reputation to fail conventionally than to succeed unconventionally.”