Novel Investor

Compounding investing wisdom...

Joel Greenblatt on the Opportunity in Misbehavior

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Joel Greenblatt is one of the rare few who can claim 40% returns over two decades. He also has a knack for explaining things simply.

He did that in his first book, You Can Be a Stock Market Genius, which explained how he earned some of that 40% return. And it showed again in his second book, The Little Book that Beats the Market.

And he did it again in his third book, The Big Secret for the Small Investor, though it’s a little different than the first two. It’s written for people new to the game, but there’s something in it for everyone.

His message is simple: the small investor has built-in advantages over the pros and there is more than one right way to invest. You can try to value stocks, evaluate fund managers, or settle for index funds. And if the typical index fund is too average for you, maybe spice things up with equal- or value-weighted funds instead. Continue Reading…

The Behavior of a Successful “Gambler”

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Finishing How to Take a Chance (notes) led me to chase down the source of a few quotes from the book. The last post was a result of that distraction. Today’s post is another — and the last of that odyssey.

In 1902, a guy named Clemens J. France wrote a study called The Gambling Impulse. It’s interesting only in the sense that he took a biological and historical perspective of gambling and chance.

The summarized version is this. Gambling has been around forever, literally since the first utterance of “Wanna bet?” It can be traced back several thousand years — Ancient Egypt, Greece, Rome, and to 2100 B.C. China. Biologically, its a battle of hope and fear, to provide a level of certainty in life. If you plan to glance through the 44 pages, the section on luck, with examples of superstitious beliefs, offered a good laugh. This seemed relevant:

In London about Throgmorton Street (the paradise of stock brokers), there used to sit a man with a bag of nuts into which passers by thrust a hand, and if they guessed correctly the number, they would be paid a penny for each, if wrong, the guesser paid a penny. Many a speculator regulated his ‘bulling’ and ‘bearing’ by his successful or unsuccessful dip into the bag.”

To think that a trader’s (in)ability to guess the number of nuts determined their feeling explains a lot about irrational markets. Continue Reading…

A Study in the Psychology of Gambling

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Why is that some people treat the dumbest bet in the world as genius when it hits? It’s not genius, obviously, but confusing skill and luck is a common mistake made by gamblers and investors alike. It’s one of many that arise when human nature and gambling collide.

When the House has the advantage, like in most games of chance, winning has nothing to do with brilliance. It’s almost always a bad decision saved by dumb luck. Yet, hindsight bias spares us from being honest with ourselves.

Picture the person who hits on 17 at blackjack and catches a 4. Or another who goes on an amazing run picking numbers playing roulette. It’s not some uncanny ability. It’s not infinite wisdom. It’s not foresight. It’s dumb luck. But the story is sold as skill.

The mistake is not only denying luck after hitting the improbable 4 on a 17 but embracing bad luck after busting from a hit on 17. The failure to account for stupidity is probably worse than being falsely endowed with unnatural gifts. Who learns from bad luck?

Of course, this problem is as old as gambling itself. Case in point is a letter to the editor of The Spectator in 1873. An insightful English gentleman shared a scathing assessment, of himself and his fellow gamblers, after his first experience in a casino. Continue Reading…

Ed Thorp on Learning from Gambling

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Ed Thorp has a skeptical mind. That’s what got him to question the belief that you couldn’t beat the casino. That same skepticism eventually drove him to question financial markets. During an interview, Thorp explained that journey and what he learned.

The big difference between gambling and investing is in the probabilities. Most gambling games have fixed probabilities. Precise accuracy is possible.

In the game of blackjack, if you know the number of decks, then you know how many of each card exists (assuming the House plays fair), and you can work out the odds from there.

Not so with investing. The complexity of markets, the number of factors involved, make precision impossible. Here’s Thorp: Continue Reading…

Steven Crist: Second Level Thinking at the Racetrack

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What does horse racing have to do with investing? Everything. The key is to think of “horses” as “stocks.”

Most gambling, like blackjack, roulette, or craps, involves betting against the House. Not so at the horse track. Instead, you bet against other bettors and your, and everyone else’s, bets on different horses (stocks) change the odds.

Not surprising, how people approach betting on horses is fairly similar to how people bet on stocks.

Steven Crist says as much in a chapter he wrote for Bet with the Best, as he explains how to bet on horses. But as I said at the top, swap out “horse” with “stock” and you’ll see the similarities with investing: Continue Reading…

Quarterly Reading – Spring ’19

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The end of March means it’s time for another quarterly reading update. A vacation in February got me back on track reading-wise. It’s amazing the number of pages you can get through when you disconnect from the internet for 10 days. Anyways, onto the books.

Here’s what I’ve been reading the past three months: Continue Reading…

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