Why I Think Your Investment Advice Is Bullshit
When you hear someone confidently declaring "BTC is going to be $100k later this year" (when its current actual price is $50k) you should probably completely discount that. If it could actually be known, based on publicly available information, that BTC would be trading at $100k later this year, then it would be about $100k right now, minus some small percentage due to time preference/interest. The reason is that skillful investors buy the asset as long as its current price is less than its expected future value (discounted by some percent for time preference). This drives the price up. This continues until there is no longer an expected profit to be gained, which means its current price is a fair estimate of its time-discounted future value.
This is the 'efficient market hypothesis'. This applies equally to stocks, gold, and all other tradeable investments. This is why you should be super-skeptical, right off the bat, about anyone who predicts large gains from any investment. Usually, it’s complete BS. They probably don’t think they’re just spouting BS, though, because many people are hair-trigger belief-formers – they form really confident beliefs based on the tiniest hints of evidence. Or they might have some detailed analysis, but it contradicts the analyses of other, equally qualified experts who are expecting the asset to hold steady or decline.
Qualifications and exceptions: These are some ways you can get large, market-beating returns:
1. Luck. There are lots of people betting on risky investments. The ones who lose you don’t hear from. The ones who happen to win trumpet their success and then try to sell you on their “system”.
Imagine a game in which you bet on the outcomes of coin flips. Each time you predict correctly, you double your money; when you predict wrong, you lose your stake. A million people play this game repeatedly. After ten coin flips, by chance, an expected 1,000 people have predicted the flip correctly every single time (1,000,000/2^10 ~ 1,000). These people go on tours of the country talking about their amazing precognitive techniques by which they turned $1000 into $1,000,000. You never hear from the people who lost.*
(*This example is from Warren Buffett’s article, “The Superinvestors of Graham-and-Doddsville”.)
This is probably by far the main way of getting big returns. This is what I think every time I see a clickbait ad of the form, “Dude who successfully predicted such-and-such gives his latest investment advice!”
2. Cheating. This might be the second leading way of getting big returns. Two forms of cheating:
(a) You trade based on information that you have that is not publicly available (e.g., you’re a company CEO and thus you know that your company is about to merge with another company). This lets you get ahead of a big market move. This is illegal, though, so I don’t recommend trying this, lest you end up sharing a cell with Martha Stewart.
(b) Other forms of fraud, like pyramid schemes, where you’re basically just stealing other people’s money. I also don’t recommend this.
3. Small markets. If you have a little-known asset, especially a new or little-known asset class, then there can be large inefficiencies, because market efficiency depends on there being sufficiently many well-informed and skillful investors, and these investors might need to see a significant history of the asset’s behavior. So a little-known asset might plausibly be greatly under- or overvalued. This was true of BTC at the beginning, but not now. (You should’ve bought it when I first blogged about it! ) By now, everyone with any interest in investing has heard of it.
4. Panics and bubbles. These are phenomena wherein a large group of people have a collective emotional reaction, either of fear or of “irrational exuberance”, where individuals are feeding off each other’s emotions. If everyone seems to be terrified, talking about how some complete disaster is about to happen (like in the 2008-09 recession), that's when assets are most likely to be greatly *undervalued*. So if you’re having trouble imagining people being more panicked, that’s the time to buy. Of course, you’ll probably be too scared to buy at that time, just like everyone else.
If, on the other hand, you’re hearing people breathlessly proclaiming how awesome this one asset (or asset class) is, that’s probably the time to sell. By my read, BTC is definitely not at the first point, but not really at the second either (i.e., there’s room for sentiment to get a lot more enthusiastic yet).
5. Amazing skill. It’s not impossible to out-predict the market by pure skill. It’s just very difficult. (See The Wisdom of Crowds for some great stories about the predictive skill of large groups of people.) Warren Buffett has demonstrated that it can be done. He gives a compelling argument that his success is not just luck in “The Superinvestors of Graham-and-Doddsville”.
This is probably the hardest and rarest way of getting big success, yet also the thing that most people would like to imagine that they’re going to do. Some caveats: although this can in principle be done, it is a priori highly unlikely that you can do it unless (i) you are very smart, (ii) you are extremely well-informed, and (iii) you are prepared to put a lot of time and effort into it. Because you have to compete with people who have all of traits (i)-(iii). Almost all people who think they are going to win through great skill are sadly deluded.
So if you see someone who tries to convince you to follow his investment advice because he’s really skilled, you should probably completely ignore that person. And if someone is trying to sell you investment advice, that is of course a scam -- if they had a great method of getting free money, they would use it themselves, and they wouldn't tell you about it, because that would cut into their own profits (if everyone knows about it, the market will become efficient and eat up all the available profits).
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I was prompted to comment on all this by the discussion I’ve seen of Bitcoin lately. I have in mind stuff like this: https://twitter.com/100trillionUSD/status/1325396958622724100 (breathlessly predicting $100k with absolute certainty).
To be clear, I’m not saying BTC is a bad investment. I’m saying I don’t know, and you don’t either. Maybe it’ll go up to 100k this year. Or maybe it’ll drop to 10k. I have no reason to think that some dudes on Twitter or Facebook who are commenting are more accurate than the market’s implicit estimate.