Fooled by Randomness

In a second, I’ll get to my thoughts on a book that I recently finished reading, but first I need to address a few administrative announcements for Dividendium.

This past week we had a server problem that caused our Inflatable Dividends data to be less than complete for a couple days. The problem has been corrected, but we will be giving all of the subscribers a refund for the current month of their subscriptions. Please let us know at if you are a subscriber and do not receive your refund.

Also this past week the extended trial period for our beta testers ended, and anyone that decided not to continue their subscription should no longer receive the emails. It is our intention not to spam any one, so we only sent one notice that this period was ending. If you were a beta tester and you wanted to continue your subscription by signing up please feel free to contact us to do so.

Lastly in the administrative announcements, we recently added a new feature to the Inflatable Dividends Service. Subscribers can now download the data for that day in spreadsheet format (.csv or comma separated values). So they can now sort, compute, and marshal that data into any form they want to pick the best investments for themselves. These spreadsheets are also going to be archived in the Inflatable Dividends Yahoo Group in case you want to look at them historically.

If the Inflatable Dividends Service interests you, give it a try. There’s a 1 month free trial when you sign up, so there’s no obligation if you decide its not for you.

Fooled by Randomness

I recently finished the book “Fooled by Randomness”, by Nassim Taleb. I found it quite intriguing from both a finance perspective and from a general life perspective.

I’m certain that I won’t do justice to the book or it’s topic by trying to discuss all of it here, so I’ll just mention a few things that I found interesting, or that struck a particular chord with me.

One theme seemed to be that of how important luck was in a person’s success and how likely that person was to end up successful if they implemented the same strategy over and over. The example of the person who is successful because they bought a lottery ticket was put forward as one where luck played a huge role. If the same situation was played over and over again a thousand times, it probably would never happen again. So following this strategy is very unlikely to result in success again.

The strategy of going to dental school and drilling teeth every day was then put forward as a highly likely success strategy. If you repeated the same “life” over many different trials, most of them would end up with the person at the same affluence level. So this strategy has less luck or chance involved in getting to the same result.

This says to me that I need to have an automated strategy to pick my stocks, specifically one that I can test and verify. This way I can make sure that my emotions or some random change in my environment are not affecting the outcome of my investing. The intent would be to create a less volatile path and a higher likelihood that my investments would end up doing well.

To this method of thinking it is better to be smart than lucky because luck or chance may not always be in your favor.

Another point was that the majority of what we hear through the media is noise. If I take the point correctly, he is saying that a journalist is paid to keep you reading. So they will pick an event and construct a story around it, whether or not that event was just a random occurrence or was actually caused by whatever story they report as the cause. An excellent example of this is the daily commentary on the market about why it went up or why it went down that single day. When in reality the amount it went up or down was just a random fluctuation without any real cause.

For this reason, he advocates ignoring the news. This kind of matches with what I said in my last post about not posting very often. The stress placed upon us by a constant call to action is actually a hindrance in our knowing when an event is actually important enough to take notice of it. There’s so much information flying at us that the information we need to know gets lost in the shuffle.

The book further cites that we as humans feel a loss two and a half times as acutely as we feel an equal sized gain. So if you gain $250, and then lose $100, you will still feel bad, even though you are still up $150. So sticking with the theme of ignoring news, this indicates that you shouldn’t be checking your stock prices daily because most likely the change on that day is just noise and has very little to do with the long term outcome. So if there is a 50% chance of a loss versus a gain on any given day you are stacking the odds in favor of you feeling bad on any given day, because you’ll need to have 2.5 gain days for every loss day to feel good, but you’ll probably end up with 1 gain day for every loss day.

His recommendation is to check the progress of your investments at much larger intervals. Like monthly or even annually if you can wait that long before needing to make the next move. Because time is a way to filter out noise and get an impression of the true value of an investing strategy.

There was much more of value in the book and I highly recommend you check it out at the library or pick it up at the bookstore if you get the … chance. I think he also has a more recent book out which I have not yet read called “The Black Swan”, but maybe I’ll let time pass and see if the new book turns out just to be noise and the excellence of the book I just finished turns out to be the black swan (a highly improbable event).

Inflatable Dividends Real Time Example Trades

I had planned to write about this last weekend, but I postponed that until we had our server under control so I could report on that at the same time.

On July 24, 2007, ALSK fell below our initial stop loss of $14.45 (it may have fallen below the stop loss by a penny on the 23rd, but I don’t have the option prices for that day, so I’ll take the lower price on the 24th instead to be more conservative). At the end of the day the price we could sell the stock at was $14.42 and the ask price for the option, the price we paid to buy it back, was $0.75. So to close the position at the end of the day we would net ($14.42 – $0.75) $13.67.

Initially we paid $16.02 for the stock and sold the call for $1.75, for a total buy in cost of ($16.02 – $1.75) $14.27. We also received a dividend of $0.215. So our base cost was ($14.27 – $0.215) $14.055.

So we paid $14.055 and got back $13.67 for a loss of .385, or 2.7% of the original investment. And we were originally looking to make about 2.98% over the course of 167 days. So we kept our loss small and we can continue to trade and stick it out until we start to realize the long-term benefits of our strategy.