Have you heard of Jim Cramer and his show on CNBC, Mad Money? He advises on investment strategy, sector selection, stock picking and the like. His primary audience are US-based retail investors.
A recent article on CNBC titled ‘Cramer: Why hot stocks don’t cut it anymore for your portfolio’ caught my attention. The article talks about how Cramer’s 11-year show transitioned from a stock-picking-specific show to being more about investment strategies and themes.
This is what Cramer said:
‘The show has changed over time from one where we pick stocks for you, to one where we educate you about stocks so you can understand why an index fund might be worth investing in’
It is very interesting to see this dramatic change in his direction. You see, Jim Cramer is one of the most vocal advisors on the airway. He is somewhat of a cultural icon, at least in the investment industry. And now he is backing away from stock picking and instead recommending index funds?
The immediate question is, is stock picking dead? To me, the answer to that question is, ‘No, not by a long shot.’ Now, I am not here to analyse Jim Cramer. I think he’s an interesting character and I hope his show goes well.
I’m here to tell you why stock picking isn’t dead.
The eternal war to win your heart
Any student of finance knows about the historical evidence for why stock picking doesn’t work. If you attended the School of Economics and Finance like I did, that is what was taught — stock pickers do not outperform the index over the long run. What immediately follows is an explanation by our dear university professors on why this acts as an incentive for index investing.
You see, I have a problem with that. And it has mainly to do with the fact that the best hedge funds and successful traders DO consistently outperform the market. But when you take all the poor, average and best money managers into account together, it naturally gives you a much poorer average.
Many outsiders are not aware of the academic warfare in the finance schools. There are two factions, the Efficient Market believers and the non-believers. The Efficient Market Hypothesis is a theory that says prices are random and nobody knows more than anybody else in the market, so there is no way for anyone to outperform the market. This theory is used to explain why the aggregate investment industry cannot outperform the index, so investors only need to invest in the index.
The non-believers, such as Warren Buffett laugh at the idea. When asked about the rising popularity of the Efficient Market Hypothesis, Buffett said he couldn’t be happier to invest in a market where the competition doesn’t believe in winning.
My belief is stock picking is alive and well, for those who do it effectively. Stock picking is ‘dead’ for those who cannot do it. And of course they would argue against stock picking. As investors, you only need to know this: it can be done, but it takes skill.
It comes down to how you do it
Another problem that hinders you is the over-categorisation the industry so clearly suffers from. There is active investing, contrarian investing, technical analysis, fundamental analysis, algorithmic investing, momentum trading…the names go on and on.
I can tell you now, no successful investor in the world would confine himself or herself to one single method. We always use a mixture of methods. Despite the nametags, you need to ‘demystify’ these seemingly-complex methodologies and take the best lessons from each one.
‘Stock picking’ is in itself a nametag. To me, stock picking simply means buying the right stocks. I honestly don’t care how those stocks are selected, as long as it works. And I know there is no way for you to outperform the market by using index-investing.
In addition, ‘demystify’ is a big part of learning to invest. For example, algorithmic trading may sound like an untouchable field of knowledge for most people. Thanks to Hollywood, we are programmed to think the word ‘algorithm’ means something highly mathematical and complex. That’s not true.
If you do a simple search on Wikipedia, you would quickly deduce that algorithm is just a ‘self-contained step-by-step set of operations to be performed’. In other words, an algorithm is simply a defined process for doing something. For example, starting up a car has a particular set of procedure to it. I can write an algorithm on that procedure, but it is nothing complicated.
Don’t be stunned by those ‘big words’ in this industry, they usually mean very little. You only have to dig a little deeper to find the right way to pick stocks.
Analyst, Emerging Trends Trader
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