CODIFICACIÓN DE CANAL EN ISDB-T

There is another school of thought that takes random walk theory and turns it upside down. In 1973, Andrew Lo, who holds a Ph.D. in economics from the University of Chicago, wrote a book called A Non-Random Walk

Down Wall Street. The one thing that makes Lo much different from his

predecessors is that he incorporated the use of technical analysis into the efficient market model. He had an attraction to technical analysis and tried, with some success, to disprove the effectiveness of random walk theory. Knowing that most of academia was subscribing to the theory, Lo concluded that most financial markets are predictable to some level. He went on to claim that the predictability of the market was not a problem based on inefficiency or irrational price action, but, rather, the predictability of the market is what makes the wheels of capitalism move. It’s simple—if liquidity providers thought there was no way they could capitalize on the inefficiency of the prices, then there would be large problems in capital formation and the entire market structure would suffer.

Lo concluded that the markets can be efficient at times but participants can profit during these periods with ongoing research and constant innova- tion. Simply put, traders that do their homework can thrive in any market environment.

Lo maintains that beating the market is not easy, nor should people think they can walk into a market condition that is emotional and expect results without hard work. Lo says that finding above-average returns on an individual’s portfolio is akin to a company trying to maintain a competitive advantage in a marketplace. If a company—any company—were to launch a new product line, the company would need to support the launch in every way possible. Management must be flexible and adapt to the ever-changing conditions, or else competitors will steal the market share.

Money managers and traders find themselves in much the same boat— if they don’t remain flexible and innovative, then they will not be able to outperform the market. As dynamic as the market may be, a trader must be just as dynamic. Just because a market strategy worked yes- terday and today does not mean it will work tomorrow. In an interview with Technical Analysis of Stocks and Commodities, Lo summarized his hypothesis:

The more creativity you bring to the investment process, the more re- warding it will be. The only way to maintain ongoing success, how- ever, is to constantly innovate. That’s much the same in all endeavors. The only way to continue making money, to continue growing and keeping your profit margins healthy, is to constantly come up with new ideas.

I remember asking Merton Miller about Lo’s work, and I found it fasci- nating that of all the economists’ work that Merton had come across about the market condition, it was Lo he liked. He pointed to the fact that he was able to incorporate the changing world and the efficiency of the market into a cohesive approach to market structure.

An important conclusion of Lo’s work is that innovation will always pro- duce a high-percentage trade at times. More important, Lo’s work foresaw the technological changes that allow the aberrations information to be dis- seminated with unimaginable speed and reliability. Even today, as we wit- ness the evolution of the entire futures market into an electronic universe, the changes needed to maintain a trading edge are still very apparent.

But one thing is certain: The time frame used to study both approaches to investing has been short. Even though the last few years have seen the market timers effectively outperform the random walkers who use the buy- and-hold strategy, history dictates that there will be a reversion to the mean. Random walkers will tell you that eventually those who time the market will not be able to maintain above-average returns. They will end up as most mutual funds on Wall Street end up—underperforming the major market averages.

The only thing that would give investors a glimmer of hope is that infor- mation has become more readily available for those wishing to participate in the market. The widespread use of the Internet and electronic trading plat- forms gives the average investor the tools and the technology to compete in today’s markets. The real question is whether the average investor knows how to use what is available. The last few years have seen an explosion in trading and investing, but little emphasis is put on education. Maybe it’s because, in the words of Woody Allen, “Those who can’t do, teach . . . and those who can’t teach, teach gym!” Unfortunately, most of the new ama- teur traders in today’s market are being taught by those who can’t do . . . or teach . . . or teach gym!

As I think back on the many great traders and portfolio managers whom I’ve encountered in my career in the futures industry, it is clear that a major- ity are from the random walk school. I remember Bing telling me that I was giving him only half the story, and I realize now that he was a true product of the efficient market theory. He came out of Harvard Business School, where subscribing to something other than random walk theory was looked upon as economic heresy. He was telling me, in his unique way, that the charts are not the reason the market is moving higher or lower. The market is moving because of events that are unknown to us.

The same was true for Vinny and Denny, who called market technical work “voodoo” but still had a certain amount of respect for what they con- sidered to be a self-fulfilling prophecy. Even Scott Weisblum, a product of Wharton, had a certain disdain for the technical work, relying instead on

the fundamental analysis of the various stock indexes and the technological edge he created for himself. All of these remarkable individuals were great traders in their own different ways but they shared one important charac- teristic: They understood the basic concept of the efficient market theory but likewise understood the need to incorporate change and innovation into their trading techniques.

C H A P T E R 8

The Psychology