Friday, June 27, 2014
Splits happen
Love the headline. I agree with Mushnick's basic point, that the level of splits we see have almost no meaning. Given the choice between the level of splits we see today, and seeing no splits at all, we'd be better of, decision-making-wise, having no splits.
The reason is because of "over fitting". What that means is that things that are in fact random are instead given meaning. The problem is that by giving it meaning, you are then taking action on that, when you would have otherwise taken the OPPOSITE decision.
You might even do this in real-life. Say that the best way to get from NYC to LA is to fly there. But, the week before, there was a plane accident. Not only that, but it was with the airline you are going to fly on. You decide "I'm not going to risk it! I'll take the train!" But, are airplane accidents more likely to occur based on the proximity of prior accidents? I have no idea, but until I see evidence to that effect, I'll assume that it's random. And even if it was NOT random, you'd then have to figure out if that puts the odds of a fatal accident higher by plane than by train.
It happens with stocks as well. Investors who chase runs and wait for a clear sign they are out of the bottom before jumping in end up making less money than those who buy-and-hold the index. That's because they think they've figured out the pattern. When there is no pattern. Maybe if you are a day trader, and you are focused on the market every second, you might figure out when to get in and get out. But then transaction fees might be your undoing.
When you give random events meaning, you end up doing the exact opposite of what you should really be doing. Basically, don't overthink the situation.?
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