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Sunday, October 25, 2009

WSJ Presentsss A Great Quote From Benjamin Graham...But Leaves Out Another One That is Even More Important

Jason Zweig of the WSJ has a nice article on individual investors and short term professional traders in the market. He points out correctly that individual than individual investors benefit from the growth of high speed automatic traders.:
Paradoxically, their frenzy renders you a service as a buy-and-hold investor: On the very rare occasions when you do need to trade, you will be able to do so more efficiently than ever before.

my bolds:

Investors unltimately benefit from the growth of high speed traders who in effect tighten spreads and make transactions less expensive. If they make some money from that activity it is nothing new. Market makers have always made spreads in exchange for providing liquidity> The high speed automatic traders executing extremely high volumes seking to make fractions of a cent on the spread make the real cost of trading (spreads not commissions) that much smaller. The markets are more efficient(in the true definition of the word) and everyone is better off than in the days of floor traders and larger spreads. And the impact of their activity is felt in the spreads of etfs and the spreads paid by index funds so one need not have a portfolio of individual stocks to benefit.

And Zweig correctly points out that most of the short term trading represents what I call "noise" relative to long term trends with exagerated movements to news and rumours (like the ones reported on that business channel) For the patient investor looking to exercise a little bit of discretion in implementing a long term strategy this can represent an opportunity (though not a riskless one of course). As nobel prize winning economist Joseph Stiglitz has pointed out in his critiques of the argument that prices our always rational and reflect all available information, there would only be a need for a few minutes of trading each day so that the prices of stocks with relevant new information were adjusted accordingly. In other words those short term movements in the daily churning usually has nothing to do with any rational market activity.

From the point of view of an investor, all this frantic trading is just noise. In 1976, the great financial analyst Benjamin Graham declared that "the stock market resembles a huge laundry in which institutions take in large blocks of each other's washing ... without rhyme or reason." Mr. Graham died that year, but today he would laugh at the speed of the spin cycle. He would then ignore the momentary vibrations in a company's stock price and go right back to analyzing the value of its business

good advice, but Zweig imo should have included the following quote from Graham late in his career:
“I have little confidence even in the ability of analysts, let alone untrained investors, to select common stocks that will give better than average results. Consequently, I feel that the standard portfolio should be to duplicate, more or less, the DJIA.”

-Benjamin Graham in The Memoirs of the Dean of Wall Street

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