Sunday 7th April, 2006

 

When there’s loss, everybody loses

 
 
 
 
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There is a story about a casino analyst employed with a brokerage firm, who was fired on the spot, when he expressed skepticism about the 1990 initiative by Donald Trump to splash into the Atlantic City casino industry. I’ll tell you why later.

Stock market risk is a form of speculative risk that is different from gambling, primarily because in the event of loss, all the owners of the particular stock, lose together.

With gambling, the casinos or lottery boards win when the gamblers lose.

Those who gain dividends on the stock market do so typically because they benefit from timing the market and following the stocks. Commonly, most people follow the leading stocks that are listed.

The neglected stock effect is the inverse of the concept of safety in large numbers.

First pioneered by researchers at Cornell University, the hypothesis proposes that under-followed stocks are really equity in “the up and coming.”

These are likely to be the ambitious and thus emerging sectors.

The researchers discovered that about half of all stocks listed in the S&P 500 are under-followed or neglected. Neglect is refined as a relative concept in this theory.

They say the neglected half tends to outperform the half that is followed.

There are reasons why this can happen. The first is that stock analysts are hired by brokerage firms.

The strategy of the brokerage is a two-pronged one: it exists to get people to buy securities from them and to make business that need to raise financing want to use their brokerage to issue securities.

The rule under the table in the stock market appears to be, that an analyst employed by a brokerage firm, cannot afford to be bearish.

The brokerage firms want you to buy and they want companies to come to them to issue securities. The image of the brokerage firms must therefore be always a positive one with a bright outlook for everything.

It is the reason why the poor fellow was fired—he was skeptical.

Once the flocks of analysts continue to follow a certain stock, there is a push effect to buy. The prices go up because a lot of well-paid analysts pay attention to its movements.

This triggers a sort of buyer confidence. But the returns to the investor may not be as attractive in the long run.

If you are looking for a king of a bargain, that is probably not the place to be.

The small companies that are not followed may be the lower-priced stocks, and with lower financing needs, they remain in the shadows.

After the fact, in-depth technical analysis often shows that these outperform big players.

The premise in technical analysis is market timing. They monitor movements in individual stocks as well as movements in the aggregate market.

These use price and volume movements and compare the relationships. They relate falling prices with falling volume, and the converse.

Technical analysis on the data leads to mapping the market and the individual stocks.

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