Random Walk Down Wall Street
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- In reading these chapters, what surprised you most? Why?
In the chapters, especially in Chapter 1, it is evident that an individual investor can actually be able to outperform the so-called ‘expert investor’. Perhaps on the basis of fundamentals, “random walk” is all about future steps and/or directions in the stock markets that are rarely predicted despite the wider application of different schools of thought, which are technical and fundamental analyses. The most surprising thing is not the fact that inflation plays a large role and poses great threat to portfolios, but actually the issue of being a “great fool” in the financial or real estate market. Furthermore, the expected productivity improvements that most analysts depend on may be absent so that there is a growing inflation (VicZhou, 2014). What surprises me most is the fact that people end up being fools by falling into psychological traps that are set right before their eyes by not foreseeing any possibility of losing should anything uncertain occur.
- Which bubble was most interesting to you? Why?
The most interesting bubble to me was the Florida Real Estate Craze. The reason is in psychological pitfalls that are easy to navigate, because we are told that the participant ‘investors’ have full knowledge of the false prices but chose to ignore it. This situation led to greater unprecedented problems that were caused by the bubble (Malkiel, 1973).
- Research a potential bubble that could potentially “pop” soon. What shared characteristics are you seeing with this bubble compared with bubbles utlined in Random Walk?
Perhaps a fundamental bubble is going to be realized in the real estate sector sooner than expected, as some experts have really analyzed the trends and conclusively state that the sector is at risk based on different economic and financial issues. These problems may be beyond the control of homeowners (Alfalfafield, 2015). In fact, the reasons are taking us back to the ‘greater fool” theory, because the real estate agents continually deny the presence of a bubble by arguing about the recently witnessed inflation in prices on unnoticed inherent values. The trend, therefore, will be continuous profit, as usual. The “fools” who are currently allured into buying these houses are going into a deeper trap because of the issue of subprime loans. The reason is simple: there is a creation of systemic risk, because the liar loans are not going to be repaid by the target demographic who actually consists of unstable income earners. This means that the bankers’ loans for the 5% down payment will be uninsured and thus correction will be uneasy. Since the beneficiaries are not the people who qualify for such high interest loans, the bubble will soon pop!
There are some shared characteristics with the bubbles in Random Walk, especially with the asset price bubble. In the case of Florida Real Estate Craze, the psychological manipulation was still the cause. People who refused to be sidelined when their neighbors were more likely to benefit than them. This is the same characteristic that is observed among the housing loan seekers who, despite their little incomes and obvious unsuitability for a loan, still want houses. The investors who participated in Florida bubble had acted with full knowledge of high prices that were existing in the hope that ‘thhe fool’ would actually pay more than such inhibitive prices. This characteristic is shared by today’s wise investors who despite inflation warnings rarely care. The other characteristic is that in both of these bubbles, there are groups of technical or fundamental analysts who believe in the castle-in-the air school of thought and usually convince investors to view the ventures as games where the players’ behaviors are likely to be predicted (Colombo, 2012).
Even after the bubble bursts, market participants maintain their faith in higher prices believing that they are rational, but they actually fall into the trap despite the fact that before the bubble, they were the most reasonable people. Applying the arguments of Malkiel as reviewed by Karsan (2009), market players are just left to observe, and conclude that efforts aimed to make money are in the right place. However, latest bubbles should be the fundamental influencing factors that make market participants losers in the end of the financial year.
There are different lessons that can be leant from this study, such as the fact that people become “greater fools” not because they do not know what to do, but because they choose to do what they ought not to do. In addition, I have learnt that investments should be diversified so as to gain even if one portfolio succumbs to economic pitfalls. Furthermore, there is need to know that chartists, who are like cultists, will be hopeful even in a 90% chance of failure. I will apply this knowledge, especially when dealing with risky portfolios, to avoid loses. Moreover, I will apply it when investing knowing that no prediction can ever be perfect in the uncertain conditions, and failure is sometimes inevitable (Malkiel, 1973)