Fooled by Randomness
I found a letter in this month’s SmartMoney that is a great example of how not to invest:
I bought 1,000 shares of Getty Images at $68.70 after reading “99Pound Gorillas” in your January issue. During the course of the next five to six months, the stock bounced around between $72 and $77. I began to view this as a trading range.
Well, in August’s “No Monkey Business Here,” you recommended taking some gains since the stock has treached $73. I was somewhat in agreement. But the following day I read, in the same issue, Paul Sturm’s “Cut Your Losses; Ride Your Winners.” The research about how people sell winning stocks too early made a lot of sense. Later that day, Getty came out with good earnings. Near the end of the week, the stock was over $82. All of this is evidence that the study discussed in Sturm’s article is 100 percent right on, for this situation.
Let’s count the mistakes:
1) Relying on someone else’s analysis (especially a magazine!) and not even making an attempt to value the security.
2) OK, he made a really bad attempt — apparently the true value can be derived from trading ranges.
3) Again, relying on a magazine for a valuation.
4) Attributing skill to a very random outcome.
5) Believing in a strategy because it worked for a very small sample. (I didn’t read — or more likely, did read but don’t remember — Sturm’s article. He may be right, but a sample size of one is completely not credible.)
The frustration I get from reading claims like these are a big reason I started this blog. (That and my wife thought I needed another outlet for my financial opinions.) Although there is little to no connection between his actions and the results, he attributes his results to his actions. Going forward, he probably won’t be so lucky — as the saying goes, a fool and his money are soon parted.
By the way, there is a very good book on this subject, Fooled by Randomness
