Continuous markets are those in which trades can occur at any time that the market is open. This can happen in one of three ways:
- An auction market, in which the trades are placed between investors without intermediaries. A trade occurs whenever the highest bid price and the lowest ask price match.
- A dealer market, in which intermediaries provide liquidity by setting minimum bid and maximum ask prices. In a dealer market, a dealer takes one side of each trade, and an investor takes the other.
- A hybrid market, in which dealers step in whenever the auction market is not sufficiently liquid.
Posted on 17th August 2008
Under: Investing in Stocks, Investing in bonds, Portfolio Management, Trading Execution | No Comments »
The level of the Chicago Board Options Exchange Volatility Index (VIX) has been shown to predict returns on equity indexes, implying either that VIX variables are priced risk factors or that markets are inefficient. In the October 2007 Journal of Banking and Finance, Banerjee, Doran and Peterson show that this relationship is strongest for high-beta portfolios.
Studies have shown that high volatility index scores are positively related to future stock market returns. In an efficient market, an observable variable such as the VIX should not have predictive power. The authors confirm that the predictive power exists, and offer support for both the market inefficiency and the priced risk arguments.
Posted on 9th August 2008
Under: Active Management, Institutional Investing, Investing in Stocks, Investment Returns, Options, Portfolio Management | No Comments »
It is generally accepted that more accurate earnings forecasts by analysts should result in superior investment performance. In the Winter 2007 Journal of Investing Fortin, Gilkeson and Michelson examine three hypotheses to determine what factors may be advance indicators of superior forecast accuracy.
Hypothesis 1 is that more frequent forecast updates represent greater analyst effort and indicate greater accuracy. No support is found for this hypothesis.
Hypothesis 2 is that (a) greater changes in successive estimates result in more accurate forecasts and (b) given a tendency toward optimism, a decrease in estimates is a stronger indicator than a similar-size increase. Tests of this hypothesis find no support and even that larger changes suggest greater error and may be a signal of higher uncertainty, regardless of direction.
Hypothesis 3 is that (a) the magnitude of the change in earnings relative to last year’s earnings indicates greater accuracy and (b) a decrease is a stronger indicator than a similar magnitude increase. They find that larger changes lead to less accuracy, but that forecast declines lead to greater accuracy.
The authors conclude that investors should avoid following recommendations of analysts who frequently revise estimates and who change forecasts by significant amounts. However, they suggest that analysts forecasting earnings declines are worth noting.
Posted on 8th August 2008
Under: Fundamental Analysis, Investing in Stocks, Research | No Comments »
Various studies have documented that the four-day period starting with the last trading day of a month and ending on the third trading day of the subsequent month accounts for the bulk of stock market returns. In the March/April 2008 Financial Analysts Journal McConnell and Xu show that this effect has persisted, and is not confined to small capitalization or low priced stocks. It occurs in 31 of the 35 countries they examined and does not appear to be caused by month-end buying pressure as measured by trading volume or equity fund money flows.
Posted on 5th August 2008
Under: Active Management, Investing in Stocks, Investment Returns, Research, Risk Management, Technical Analysis | No Comments »
High quality securities markets are those that supply liquidity, transparency and assured completion.
Liquidity can be defined a number of ways:
- Tightness (low bid/ask spread)
- Depth (limited price impact from large trades)
- Resiliency (rapid adjustments for discrepancies between market price and intrinsic value)
Transparency means access to quotes is quick, easy and inexpensive. It also requires that trade details (size and price) are rapidly disseminated to the public.
Assurity of completion simply means that the counterparties of a trade can be trusted to honor the trade.
Posted on 3rd August 2008
Under: Active Management, Institutional Investing, Investing in Stocks, Risk Management, Trading Execution | No Comments »
Persistent mispricings should attract profit-seeking investors to exploit them. This, in turn, should eventually cause the anomaly to disappear. There are several potential reasons for anomalies to persist.
Certain anomalies may not have a logical explanation, causing investors to be wary of trying to exploit them.
Particularly for less liquid securities, there may be significant costs involved in trading them. The higher the costs, the greater a mispricing must be in order for arbitrageurs to try to exploit it.
Large investors, in particular, may find that certain mispricings do not offer a significant return for the time involved in identifying and exploiting them.
Many investors have limits imposed on their activity, such as a prohibition on short selling. Such prohibitions can prevent investors from exploiting opportunities when identified.
Posted on 30th July 2008
Under: Active Management, Investing in Stocks, Investment Returns, Passive Management | No Comments »
In Technical Analysis Explained, Martin Pring notes that since there are three major financial markets (stocks, bonds and commodities) and each has two turning points in a given cycle, there are six turning points in each cycle. He calls these turning points the six stages and uses them as a reference point for identifying the current phase of the business cycle and by extension the next likely turning point.
Stage 1: Slowing growth rates or early recession. Interest rates start to fall and bonds rally.
Stage 2: Business cycle trough. Stocks begin to rally.
Stage 3: Late recession and early recovery. Commodities begin to rally.
Stage 4: Early recovery. Interest rates trough and bonds peak.
Stage 5: Cycle peak. Stocks peak.
Stage 6: Slowing growth, commodities peak.
Posted on 25th July 2008
Under: Economic Analysis, Investing in Commodities, Investing in Stocks, Investing in bonds, Technical Analysis | No Comments »
Call based securities markets attempt to gather all the bids and asks for a security at a specific time, with the intent being to price a trade that will match the quantity demanded with the quantity supplied.
Many markets use a call system to set the opening price for securities. The opening price then reflects all the buy and sell orders placed since the previous close.
Posted on 17th July 2008
Under: Investing in Stocks, Investing in bonds | No Comments »
For individuals drawing on retirement funds, a 4% withdrawal rate is generally recommended to result in only a small chance of the portfolio running out of money. In the October 2007 Journal of Financial Planning Spitzer, Strieter and Singh simulate thousands of 30-year periods to assess the overall probability of running out of funds.
They find that a standard 50/50 split between stocks and bonds can allow for a 4.4% withdrawal rate with just a 10% chance of depleting funds. Withdrawal rates of up to 6% can be supported with stock allocations of 75% or more.
Posted on 10th July 2008
Under: Asset Allocation, FInancial Planning, Investing in Stocks, Investing in bonds, Investment Returns, Personal Finance, Portfolio Management, Research, Risk Management | No Comments »
Portfolio management theory asserts, based on the variance between a given asset and the rest of the portfolio, that as few as 8-20 stocks are sufficient to provide most of the benefits of diversification.
In the November 2007 Financial Review Domian, Louton and Racine challenge this assumption by proposing that long-term investors are likely to be more concerned with shortfall risk (failure to reach a target ending wealth) than with return variance.
Based on the returns of 1,000 stocks and a safety first criterion, they find that at least 164 stocks are necessary to reduce shortfall risk to no more than a 1% chance of underperforming Treasury bonds. Although smaller portfolios can be enhanced by diversifying across industries, the benefit is not as powerful as that provided by simply adding more stocks to the portfolio.
Posted on 9th July 2008
Under: Active Management, Asset Allocation, FInancial Planning, Institutional Investing, Investing in Stocks, Investment Returns, Passive Management, Performance Measurement, Portfolio Management, Research, Risk Management, Security Selection | No Comments »