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Wednesday, July 15, 2009

Why Can't I Pick Winning Lottery Numbers?

My relatives have posed the following question to me over and over again.

FSK, if you're so good at Math, then why can't you predict what numbers are going to win the Lottery? You'd make a fortune!

I try explaining to them the futility of that. Presumably, the lottery is a random draw. Given that information, any patterns I would find would merely be random noise. When you attempt to data mine random numbers, you may see patterns that aren't really there.

Attempting to data mine historic lottery data for patterns is pointless. The auditors of the Lottery do their best to ensure a fair random drawing. Even if the auditors are cheating, they certainly aren't going to tell me!

I realized that the following question is exactly the same.

FSK, if you're so smart, then why can't you make a fortune in the stock market?

After careful consideration, this is the exact same question as "Why can't FSK predict lottery numbers?"

Most of the people who make a fortune in the stock market are investing *OTHER PEOPLE'S MONEY*. Suppose a hedge fund manager raises $1B in capital (a small fund). He earns a return of 20%, which isn't that hard when inflation is 30%+. He charges the usual "20% of gain plus 1%" management fee. This is a fee of $50M ($40M (20% of $200M) plus $10M (1% of $1B)). The return underperformed inflation! The hedge fund manager claims he did a brilliant job, and his investors are thanking him for his brilliant insight!

If you're investing other people's money, it's very easy to earn a fortune by charging them a fee of a couple percent. A hedge fund manager charges his customers for a return that is less than true inflation. Similarly, a CEO earns a huge salary because he's managing billions of dollars of resources, when he isn't the owner. By leeching a tiny percentage of the resources he controls, the CEO earns a huge salary. Most people who earn huge salaries via State violence are benefiting from "Manage other people's money and exploit the Principal-Agent problem."

You might say "Well, why don't you convince people to invest $1B with you?" This comes down to parasite skills instead of productive skills. Frequently, the person investing in the hedge fund is a pension fund or "fund of funds". Then, there's the usual corrupt bargain. The hedge fund manager will hire the brother-in-law of the person managing the pension fund, in return for an investment. The person making the "invest in hedge fund" decision is himself investing other people's money.

It also is possible to make money trading stocks if the structural rules of the market are biased in your favor. At a large brokerage, like Goldman Sachs, their internal trading desk gets to see an order before it is sent to the market. For example, suppose you send an order to Goldman Sachs "Buy 1000 shares of XYZ at market.", when the offer price is $10. If Goldman Sachs' trading desk thinks that $10 is a good price, then they will sell you the shares for $10 from their own account. If they don't think that $10 is a good price, then they'll send your order to the market and get the price there. This is an advantage for the trader at Goldman Sachs. It comes at the expense of other market participants.

Similarly, the specialist on the NYSE makes money not because he's a brilliant trader. He makes money because the structural rules of the market are biased in his favor. These profits are paid as higher transaction costs for other market participants.

The profits of hedge fund managers, CEOs, and the banksters are not because they're brilliant businessmen. They are collecting economic rent, because the rules of the market are biased in their favor. State restriction of the market prevents competition. Even though large established corporations are incredibly inefficient, there are huge State-imposed barriers to starting a new competing business. This is not a natural free market occurrence.

I can't profitably start my own stock short-term trading business, because I'm competing at unequal footing to other market participants.

Further, I don't get the perk of using lots of leverage at favorable interest rates, like the hedge fund manager or banker get.

When I realized that the stock market underperforms true inflation over time, it was like discovering that Santa Claus doesn't exist. For any State-sanctioned investment I choose, my savings are eroded by inflation or fees. The best I can expect is a 0% inflation-adjusted return by investing in physical gold or silver, and storing it in a safe location.

I noticed this is a common evil fnord. "FSK is smart. FSK's skills are best put to use in the parasite sector of the economy.", "FSK is smart and therefore he can predict lottery numbers.", and "FSK is smart and therefore he can make a fortune in the stock market." are closely related false beliefs.

One big evil of the State is that many of the smartest people are focusing their efforts on the parasite sector of the economy. Working as a quantitative analyst in the parasitic financial industry pays a lot better than doing something actually useful. I don't fit into the wage slave economy. I'm a very skilled worker, but I also want a job that isn't a complete waste of my skills and abilities! I don't fit into a business where I'm working for parasites, because they get offended at me when I can see through their scam.

1 comment:

Anonymous said...

At a large brokerage, like Goldman Sachs, their internal trading desk gets to see an order before it is sent to the market.

Do you have actual evidence of this, because it's a scandal that's building on Wall Street right now?

If it's just conjecture, I certainly agree, but say that it's conjecture. GS has colocation at the NYSE and with shitty network security, I wouldn't be surprise if GS could sniff the line and disrupt trading flow.

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