By now I am sure all of you are aware of statistics guru, Nate Silver.
The unabashed numbers geek, professional poker player, baseball statistician and creator of the FiveThirtyEight blog on The New York Times website correctly predicted the outcome of all 50 states. In 2008 he accurately predicted 49 out of 50 states.
Given his track record, Silver appears to have ushered in a new level of credibility for statistical analysis.
I think political journalist Dan Lyons said it best, “his accuracy on this year's election represents what I call a victory of logic over punditry. Nate Silver was right and the pundits were wrong. And Silver won because of, well, mathematical science. Silver’s methodology is based solely on statistical data. He takes deep data sets and applies logical analytical methods to them.”
Silver indeed proved that statistics, not personal biases, are the wave of the future.
And this is exactly how I approach investing.
Coincidentally, I have a win record on the S&P 500 (SPY) similar to Nate Silver’s record on elections. He’s 99/100 picking the individual states, and I’m 13/13 over the past year in SPY (my win ratio is over 91% for ETFs I use in the Options Advantage portfolio). While I know losers are inevitable due to the elements of uncertainty and margins of error (investing is never an area where we should expect 100% accuracy), you can’t deny that probabilities are a viable way to invest a portion of your hard-earned capital.
The age of intelligence is here. We have the ability to accurately predict the probability of investments. It’s just a matter of overcoming the “old guard” mentality.
Moreover, as Mr. Lyons states, “the age of voodoo is over. One by one, computers and the people who know how to use them are knocking off these crazy notions about gut instinct and intuition that humans like to cling to. For far too long we've applied this kind of fuzzy thinking to everything, from silly things like sports (Moneyball, “sabermetrics”) to important stuff like medicine.” Dan, let’s not forget the biggest offender of them all – the finance industry.
It's not hard to see the analogies with the stock market. The markets are awash with pundits, analysts and sooth-saying forecasters providing a running commentary of the impact of what's happening now on the future.
If you read the newspapers discussing company results, there's inevitably a quote from some analyst from such and such investment bank pontificating on what these results will mean for the company's future performance.
The fuzzy logic presented by the “old guard” of finance – the Bloombergs, CNBCs, and other archaic sources – is over … at least for the statistically inclined. But unlike most of the other industries that have fallen to statistics, the investment industry is powerful. And they will do whatever they need to do to keep eyes on the screen.
They have to. Because when the self-directed investor finds out there is a real, tangible way to invest using statistical probabilities rather than the “fuzzy logic” of financial analysts, the walls of the industry will begin to crumble.
Fundamental analysis, technical analysis and the ongoing financial noise that is spewed on a daily basis is simply an engagement tool.
Disgree? Well, famed contrarian investor David Dreman discusses in great detail the appalling track record of analyst forecasting in his book, Contrarian Investment Strategies. More recent work by noted value investor and author James Montier found that:
In the US, the average 24-month forecast error for individual stocks is 93%, and the average 12-month forecast error is 47% over the period 2001-2006. The data for Europe are no less disconcerting. The average 24-month forecast error is 95%, and the average 12-month forecast error is 43%. To put it mildly, analysts don't have a clue about future earnings.
Statistics as seen through mean-regression, probabilities, standard deviation, binomial models etc. is how self-directed investors should start to view both the market and potential investments. It sounds difficult, but it’s not. In fact, it’s surprisingly easy.
If you are interested in learning more about how I approach the market in great length you can access my newly published White Paper and special report. You can receive both reports, plus several other special reports, not to mention two free months of the Options Advantage service for $39. Of course, if you are not satisfied you can cancel at anytime. Click here to access the reports.
And as always, feel free to email me with any questions that you might have at firstname.lastname@example.org.
Editor and Chief Options Strategist