>Literally every single paper was either p-hacked, overfit, or a subsample of favourable data was selected
including methods that use:
>News Text Mining. - This is where they'd use NLP on headlines or the body of news as a signal.
I have to call this out.
Is this author suggesting that you couldn't have made money by shorting Enron stocks milliseconds after the scandal was made public? Is it impossible to make money by buying a stock in a small company, seconds after an acquisition is announced? If a CEO gets sent to prison, will that company's stocks not be affected?
And then there are other methods that use:
>Fundamental data. So ratios from the income statement/balance sheet
So buying stocks in companies with good financial health is not profitable?
> Is this author suggesting that you couldn't have made money by shorting Enron stocks milliseconds after the scandal was made public?
No, he's claiming that any of the actual published systems, if they would correctly have made money on that one special event, would not do so on enough other events to make up for those they would lose money on plus transaction costs on all the trades they would make to actually beat a broad market index.
It's pretty easy to (with hindsight) design a system that would make money on Enron or any other isolated event. It's harder to build a system that will consistently beat the market on future events that it's not designed against.
The important concept to understand about profitable investing is that you have to have a strategy that others are not also using.
Sure, investing in companies in good financial health is profitable. Unless everyone else does it too, and they drive up the price of the profitable companies, until all upside is gone (i.e., price is baked in). You're not better at finding profitable companies than anyone else.
Shorting stock on headlines? Sure, if you can beat everyone else. (You can't.)
The other is merely stating that, according to his analysis, apparently all these strategies did not bring an edge to the market.
Stocks do not tend to go up, that would imply a greater than 0 return average for series. We instead get mean blur and skewness (which is actually often to the left).
The aggregate of the traded stocks, i.e. the market, goes up on average. That's why you make money by holding diversified portfolios.
"The important concept to understand about profitable investing is that you have to have a strategy that others are not also using."
People always say this, but it doesn't make sense to me.
If I go to the grocery store and buy produce, and I assume I'm not more knowledgeable than an expert purchaser for a food service business, then am I necessarily better off buying stuff at random without even looking at it? If I'm really clueless, can I not learn to choose good stuff by examining it and trying it, and finding out what other people look for?
The problem, I think, is that when people are looking for a way to beat the market, they, pretty much without exception, look for ways to process the predigested information about a select group of companies that is already in a structured form. That stuff is the information that's most absorbed into prices, so why not stop "looking for your keys under the streetlight"?
Precisely because the market is very efficient at pricing everything that people can quantify, you don't have to quantify much at all! If you can tell rotten fruit from fresh, then you are adding value and you can assume that everything that you find difficult to evaluate is already factored in.
What if you just spent 10 seconds looking at each business description of a public company's 10-K? Instead of looking at numbers at all, just treat your investing like you have a stack of several thousand resumes and you need to hire 20. Of course, you want to look at some numbers later on before buying, just like doing a background check on a prospective employee, but just looking at a broad cross section of what's out there is enough to observe really obvious and educational patterns.
Here's something I read in a 10-K recently:
"In July 2014 as part of a diversification strategy we acquired companies engaged in the manufacture and marketing of electro-hydraulic servo-valves and the development of optical fiber hardware and software solutions for the security and protection industry. However, in the fourth quarter of 2015, we decided to focus on our hog farming operations, sell our operations in electro-hydraulic servo-valves and optical fiber based security & protection and seek to grow through internal expansion and acquisitions of businesses in the agricultural industry."
Now, if the market is efficient, and I am not an expert in hog farming, servo valves, or investing then how can I tell if this company is a better or worse bet (at the current price) than, say, Apple?
I see where you're going with the grocery store produce analogy, but it's not a useful analogy for how markets work.
1. Those grocery store items (let's say tomatoes) are priced equally to each other, by decision of the supermarket. This is not true of securities, which are individually traded and priced separately, which allow differences to be priced in.
2. The market for tomatoes at your local grocery store is geographically constrained, limiting the number of participants. This is not true of publicly traded stocks that nearly anyone in the world can trade.
3. The amount of money that can be put to use finding efficiencies at your local market is small. In global markets, the payoff is in the billions, and so many people are scouring for similar efficiencies - and in the process, eliminating them.
4. The tomato market has high transaction costs. What are you going to do when you find a better tomato for the same price? Sell it to someone else for a higher price? No. The arbitrage opportunity for tomatoes doesn't exist.
Efficient markets is not a thesis that is required to be true of all markets by some sort of law. They are a consequence of liquid markets that are large and traded by many well-funded participants. The analogy must have the same factors to be valid.
they're probably not accounting for HFT. that's not unreasonable to expect.
> So buying stocks in companies with good financial health is not profitable?
everybody has the same common sense, prices reflect all available information (at least, if you believe the efficient market hypothesis, which I do to some extent). so you shouldn't expect the method to be profitable in excess of the overall market profit -- what we call alpha.
The market is not perfectly efficient. Small cap stocks outperform large cap stocks; the S&P500 outperforms leaving money under your mattress.
I am more than willing to bet that if you combine these methods with an algorithm that estimates a stock's "proper price" with the information, a sophisticated algorithm should be able to at least outperform a layman's "Buy-and-Hold" strategy.
You can put your money on that, but you would pretty consistently, it turns out, be wrong. Which you would know if you had read the OP.
Profiting off of other people's tendency to trade too much and too confidently is some of the surest money in the market, because regardless of evidence people want to believe that they can positively effect the outcome. Nest eggs are more like soufflés than caramels.
>Profiting off of other people's tendency to trade too much and too confidently is some of the surest money in the market
This proves my point; this statement is counter to the efficient market hypothesis, and it shouldn't be too difficult to algorithmically find trigger events that cause people to trade too much and too confidently.
Published academic studies on the size factor go back decades. I'm not ready to consider them refuted because someone on reddit says he google searched papers from the last eight years and found them lacking, especially since he doesn't specifically claim to debunk any of the major factors, and the momentum factor he even confirms.
> the S&P500 outperforms leaving money under your mattress
This doesn't conflict with the efficient market hypothesis. The S&P500 also outperforms 'investing' in blackjack. No one is claiming that holding your money as cash is on the efficient frontier.
>No one is claiming that holding your money as cash is on the efficient frontier.
But it would be in an efficient market. As more investors invest in more profitable assets, the price of those assets rise, which makes the return on those assets fall relative to the initial cost. The Efficient Market Hypothesis, in it's strongest form, implies that every asset is on the efficient frontier.
1) You‘d still get a risk premium, because only known information can be priced into the stock. Unkown information is risk.
2) Capital is rare. There is no unlimited supply, so it‘s distributed between assets as well as available information allows. But there is still unsatisfied capital needs where the money can be employed more efficient than holding it cash.
So an investor that can anticipate an increase in, decrease in, or general level of a) market risk, b) a market's risk premium, or c) available market capital, can predict market movements. Just because CFAs use fancy names for market imperfections doesn't mean that they're not exceptions to the EMH.
Yes, and value stocks outperform growth stocks over long enough periods of time too. But what does that have to do with the market not being efficient?
The academic explanation for why small cap and value outperform large cap and growth is that small cap and value companies are riskier investments. The factor risk premiums exist because investors need a higher return to reward them taking on more risk.
Risk premiums actually support the existence of an efficient market.
> Is this author suggesting that you couldn't have made money by shorting Enron stocks milliseconds after the scandal was made public?
Enron's collapse was 18 years ago. I suspect if this happened today, with today's trading environment, the answer to your question would be "yes." The algos today will parse an article, enter & exit a trade faster, than a human can read the headline.
> So buying stocks in companies with good financial health is not profitable?
That alone, probably not. You need to have an edge. If everyone else knows it's financial health clearly, then the price is already "bought up."
This brings an interesting point regarding reproducibility in economics. It's possible for a paper to be legit and be good science, but the moment it's published it becomes irreproducible because other actors are going to use the published approach from now on and the balance in a game theoretic way is not the same. By publishing a paper you can change the thing you are studying.
This is what the author is talking about when he says "alpha decay." He tried to account for it with backtesting (so simulating a market that has no knowledge of these strategies) and the strategies still failed.
> That alone, probably not. You need to have an edge. If everyone else knows it's financial health clearly, then the price is already "bought up."
This is untrue. FAANG (all healtly companies) have been outperforming the S&P500 consistently. In fact, investing in FAANG is probably the "dumbest" smart play you can make. And, alas, you still come out on top.
Yes, and Enron was incredibly healthy too. Netflix has recently seen a downturn. The "health" of companies is not a constant. Can you predict when it will sour? Or are you certain that these companies will never fail? If so, why?
I think it's a bit of a stretch to say that FAANG stocks have "consistently" beaten the S&P 500. Most of the FAANG companies haven't even existed for long enough to draw meaningful conclusions from. The one that has (Apple) once underperformed the S&P 500 for 11 years from 1993 to 2004.
The claim is that you can't do it consistently. Your sentiment detector has to more accurately capture the state of a randomly selected set of companies (not one selected with the benefit of hindsight, like Enron) based on news sentiment than the information already incorporated into the stock's price.
including methods that use:
>News Text Mining. - This is where they'd use NLP on headlines or the body of news as a signal.
I have to call this out.
Is this author suggesting that you couldn't have made money by shorting Enron stocks milliseconds after the scandal was made public? Is it impossible to make money by buying a stock in a small company, seconds after an acquisition is announced? If a CEO gets sent to prison, will that company's stocks not be affected?
And then there are other methods that use:
>Fundamental data. So ratios from the income statement/balance sheet
So buying stocks in companies with good financial health is not profitable?
Something's being left out here.