Judging The Keynesian “Beauty Contest”

Shhh. I have a confession: I don’t like picking stocks. It has never been my thing.

John Maynard KeynesAt my old office, it was a job for analysts in the research department. And most of the time, their stocks were picked for them anyway, i.e. they wrote about companies that had investment banking relationships with the firm. Or they wrote industry overviews pertaining to sectors that the bulk of the firm’s corporate finance clients came from.

The group I worked with was different: we were traders. Day in, day out, we traded stock index and commodity futures as well as currencies. Stocks were viewed in two ways. First, we accumulated positions. I won’t go into that today. Second, there was trading as a seasonal activity. We only traded “story” stocks with volume, stuff that was “in play”, the bubbles of the month. We didn’t pick the stocks; the market did it for us. Once the game was over, we moved on.

To paraphrase my boss, the reason for our approach went something like this: “Don’t worry. There are two reasons why we will continue making money for the foreseeable future. 1. There is a new one born every minute, and 2. The supply of money is ever growing.”

I hadn’t thought of that in a long time, and you know, the more I think about it, the more it makes sense. Of course, it would have been easier if Colin Camerer‘s Taxi Drivers and Beauty Contests were available back then.

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Or perhaps I should have been more diligent while studying economics:

(4) But there is one feature in particular which deserves our attention. It might have been supposed that competition between expert professionals, possessing judgment and knowledge beyond that of the average private investor, would correct the vagaries of the ignorant individual left to himself. It happens, however, that the energies and skill of the professional investor and speculator are mainly occupied otherwise. For most of these persons are, in fact, largely concerned, not with making superior long-term forecasts of the probable yield of an investment over its whole life, but with foreseeing changes in the conventional basis of valuation a short time ahead of the general public. They are concerned, not with what an investment is really worth to a man who buys it “for keeps”, but with what the market will value it at, under the influence of mass psychology, three months or a year hence. Moreover, this behaviour is not the outcome of a wrong-headed propensity. It is an inevitable result of an investment market organised along the lines described. For it is not sensible to pay 25 for an investment of which you believe the prospective yield to justify a value of 30, if you also believe that the market will value it at 20 three months hence.

Thus the professional investor is forced to concern himself with the anticipation of impending changes, in the news or in the atmosphere, of the kind by which experience shows that the mass psychology of the market is most influenced. This is the inevitable result of investment markets organised with a view to so-called “liquidity”. Of the maxims of orthodox finance none, surely, is more anti-social than the fetish of liquidity, the doctrine that it is a positive virtue on the part of investment institutions to concentrate their resources upon the holding of “liquid” securities. It forgets that there is no such thing as liquidity of investment for the community as a whole. The social object of skilled investment should be to defeat the dark forces of time and ignorance which envelop our future. The actual, private object of the most skilled investment to-day is “to beat the gun”, as the Americans so well express it, to outwit the crowd, and to pass the bad, or depreciating, half-crown to the other fellow.

This battle of wits to anticipate the basis of conventional valuation a few months hence, rather than the prospective yield of an investment over a long term of years, does not even require gulls amongst the public to feed the maws of the professional; — it can be played by professionals amongst themselves. Nor is it necessary that anyone should keep his simple faith in the conventional basis of valuation having any genuine long-term validity. For it is, so to speak, a game of Snap, of Old Maid, of Musical Chairs — a pastime in which he is victor who says Snap neither too soon nor too late, who passes the Old Maid to his neighbour before the game is over, who secures a chair for himself when the music stops. These games can be played with zest and enjoyment, though all the players know that it is the Old Maid which is circulating, or that when the music stops some of the players will find themselves unseated.

Or, to change the metaphor slightly, professional investment may be likened to those newspaper competitions in which the competitors have to pick out the six prettiest faces from a hundred photographs, the prize being awarded to the competitor whose choice most nearly corresponds to the average preferences of the competitors as a whole; so that each competitor has to pick, not those faces which he himself finds prettiest, but those which he thinks likeliest to catch the fancy of the other competitors, all of whom are looking at the problem from the same point of view. It is not a case of choosing those which, to the best of one’s judgment, are really the prettiest, nor even those which average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practise the fourth, fifth and higher degrees. — John Maynard Keynes, Chapter 12, The General Theory of Employment, Interest and Money

So there we have it. I do know something about stock picking after all!

MORE: Ranking Cute Animals: A Stock Market Experiment


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  1. Teresa,

    I prefer to make a dumb question than to make (another) dumb action (trade). How are we supposed to use (if one wants) the trading ideas?

    1. A reading of sell means short selling?
    2. On the opposite a meaning of buy means going long?
    3. Or are they signal of getting out if you were on that position (the opposite)
    4. Or maybe it’s just an automatic scanner that filters positions that are strong candidates for a reversal.

    Also the change column (where they are ranked against the S&P500 and the Nasdaq 100 from when it is measured this change? Is it the last 20 days?

    Sorry, my native tounge is not English and I must be missing something. Thanks for your patience and understanding.


  2. Chris Johnson was on CNBC talking about the 4 sentiments of a bull market. Maybe he should pick up a copy of Justin Mamis’s book “The Nature of Risk”, to get the full sentiment cycle. Or at the least, start reading InvivoAnalytics.com.

  3. Today’s list said it found XX winners and XX losers. I checked the list and I can’t tell how you are determining how many there are.

    When I count the price changes +- it is different from that; and also the number of buy and sell stops are different from that. So how do you figure the number of winners and losers?

  4. Sorry for the confusion, Bruce. We classify the stocks as winners and losers based on a number of criteria rather than just price change on the day.

    To avoid confusion in the future, we’ve decided to post the list of winners on days when the S&P 500 Index closes lower while we will post the list of losers on days when $SPX closes higher.

    The lists will provide more insight this way.

  5. Are definitions of the column headers in the google spreadsheets available? It is unclear as to how the data in the spreadsheets should be interpreted without them.

  6. Let’s go over the columns one by one.

    • TICKER = Symbol
    • VOLUME = Number of shares traded on the day
    • TRADES = Number of trades on the day
    • CLOSE = Closing price on the day
    • %Change = Percent change from previous day’s close
    • SELL BELOW = Can be used as the exit price for long position OR as the entry price to open a short position. This number is generated by InVivo.Stops set at the default StopFactor = Universal and corresponds to the PINK dots found on our charts. Details and the official buy and sell rules, please see InVivo Trading Tools.
    • BUY ABOVE = Can be used as the exit price for short position OR as the entry price to open a long position. This number is generated by InVivo.Stops set at the default StopFactor = Universal and corresponds to the BLUE dots found on our charts.
    • %ToSignal = The percent move from the closing price before the pink or blue dot is reached.
    • HIST VOLAT = Historical volatility a.k.a. volatility standard deviation a.k.a. realized volatility.

    TradeStation says, “The Volatility Std Dev indicator calculates and plots the volatility of a market using prices from the number of bars specified by the input Length. The value returned is 1 annual standard deviation in price expressed as a percent of the market price. Options traders will recognize the Volatility StdDev indicator is akin to statistical volatility. While you can apply this indicator to any time frame, it is designed for use with daily bars because the values are annualized based on a daily timeframe. Using another time frame causes the values not to be accurate because the annualization is not calculated properly.

    We use Length = 21 for HIST VOLAT. In general, the higher the historical volatility reading, the more a stock has been “thrashing” and may be close to the end of a trend. Stocks with high HIST VOLAT readings are probably more suitable for intraday trading rather than swing trading.

    More at Using The Daily Worksheet.

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