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Market Sense and Nonsense: How the Markets Really Work (and How They Don't)

Book Description

Bestselling author, Jack Schwager, challenges the assumptions at the core of investment theory and practice and exposes common investor mistakes, missteps, myths, and misreads

When it comes to investment models and theories of how markets work, convenience usually trumps reality. The simple fact is that many revered investment theories and market models are flatly wrong—that is, if we insist that they work in the real world. Unfounded assumptions, erroneous theories, unrealistic models, cognitive biases, emotional foibles, and unsubstantiated beliefs all combine to lead investors astray—professionals as well as novices. In this engaging new book, Jack Schwager, bestselling author of Market Wizards and The New Market Wizards, takes aim at the most perniciously pervasive academic precepts, money management canards, market myths and investor errors. Like so many ducks in a shooting gallery, Schwager picks them off, one at a time, revealing the truth about many of the fallacious assumptions, theories, and beliefs at the core of investment theory and practice.

  • A compilation of the most insidious, fundamental investment errors the author has observed over his long and distinguished career in the markets

  • Brings to light the fallacies underlying many widely held academic precepts, professional money management methodologies, and investment behaviors

  • A sobering dose of real-world insight for investment professionals and a highly readable source of information and guidance for general readers interested in investment, trading, and finance

  • Spans both traditional and alternative investment classes, covering both basic and advanced topics

  • As in his best-selling Market Wizard series, Schwager manages the trick of covering material that is pertinent to professionals, yet writing in a style that is clear and accessible to the layman

Table of Contents

  1. Cover
  2. Contents
  3. Title
  4. Copyright
  5. Dedication
  6. Foreword
  7. Prologue
  8. Part One: Markets, Return, and Risk
    1. Chapter 1: Expert Advice
      1. Comedy Central versus CNBC
      2. The Elves Index
      3. Paid Advice
      4. Investment Insights
    2. Chapter 2: The Deficient Market Hypothesis
      1. The Efficient Market Hypothesis and Empirical Evidence
      2. The Price Is Not Always Right
      3. The Market Is Collapsing; Where Is the News?
      4. The Disconnect between Fundamental Developments and Price Moves
      5. Price Moves Determine Financial News
      6. Is It Luck or Skill? Exhibit A: The Renaissance Medallion Track Record
      7. The Flawed Premise of the Efficient Market Hypothesis: A Chess Analogy
      8. Some Players Are Not Even Trying to Win
      9. The Missing Ingredient
      10. Right for the Wrong Reason: Why Markets Are Difficult to Beat
      11. Diagnosing the Flaws of the Efficient Market Hypothesis
      12. Why the Efficient Market Hypothesis Is Destined for the Dustbin of Economic Theory
      13. Investment Insights
    3. Chapter 3: The Tyranny of Past Returns
      1. S&P Performance in Years Following High- and Low-Return Periods
      2. Implications of High- and Low-Return Periods on Longer-Term Investment Horizons
      3. Is There a Benefit in Selecting the Best Sector?
      4. Hedge Funds: Relative Performance of the Past Highest-Return Strategy
      5. Why Do Past High-Return Sectors and Strategy Styles Perform So Poorly?
      6. Wait a Minute. Do We Mean to Imply . . .?
      7. Investment Insights
    4. Chapter 4: The Mismeasurement of Risk
      1. Worse Than Nothing
      2. Volatility as a Risk Measure
      3. The Source of the Problem
      4. Hidden Risk
      5. Evaluating Hidden Risk
      6. The Confusion between Volatility and Risk
      7. The Problem with Value at Risk (VaR)
      8. Asset Risk: Why Appearances May Be Deceiving, or Price Matters
      9. Investment Insights
    5. Chapter 5: Why Volatility Is Not Just about Risk, and the Case of Leveraged ETFs
      1. Leveraged ETFs: What You Get May Not Be What You Expect
      2. Investment Insights
    6. Chapter 6: Track Record Pitfalls
      1. Hidden Risk
      2. The Data Relevance Pitfall
      3. When Good Past Performance Is Bad
      4. The Apples-and-Oranges Pitfall
      5. Longer Track Records Could Be Less Relevant
      6. Investment Insights
    7. Chapter 7: Sense and Nonsense about Pro Forma Statistics
      1. Investment Insights
    8. Chapter 8: How to Evaluate Past Performance
      1. Why Return Alone Is Meaningless
      2. Risk-Adjusted Return Measures
      3. Visual Performance Evaluation
      4. Investment Insights
    9. Chapter 9: Correlation: Facts and Fallacies
      1. Correlation Defined
      2. Correlation Shows Linear Relationships
      3. The Coefficient of Determination (r2)
      4. Spurious (Nonsense) Correlations
      5. Misconceptions about Correlation
      6. Focusing on the Down Months
      7. Correlation versus Beta
      8. Investment Insights
  9. Part Two: Hedge Funds as an Investment
    1. Chapter 10: The Origin of Hedge Funds
    2. Chapter 11: Hedge Funds 101
      1. Differences between Hedge Funds and Mutual Funds
      2. Types of Hedge Funds
      3. Correlation with Equities
    3. Chapter 12: Hedge Fund Investing: Perception and Reality
      1. The Rationale for Hedge Fund Investment
      2. Advantages of Incorporating Hedge Funds in a Portfolio
      3. The Special Case of Managed Futures
      4. Single-Fund Risk
      5. Investment Insights
    4. Chapter 13: Fear of Hedge Funds: It’s Only Human
      1. A Parable
      2. Fear of Hedge Funds
    5. Chapter 14: The Paradox of Hedge Fund of Funds Underperformance
      1. Investment Insights
    6. Chapter 15: The Leverage Fallacy
      1. The Folly of Arbitrary Investment Rules
      2. Leverage and Investor Preference
      3. When Leverage Is Dangerous
      4. Investment Insights
    7. Chapter 16: Managed Accounts: An Investor-Friendly Alternative to Funds
      1. The Essential Difference between Managed Accounts and Funds
      2. The Major Advantages of a Managed Account
      3. Individual Managed Accounts versus Indirect Managed Account Investment
      4. Why Would Managers Agree to Managed Accounts?
      5. Are There Strategies That Are Not Amenable to Managed Accounts?
      6. Evaluating Four Common Objections to Managed Accounts
      7. Investment Insights
  10. Postscript to Part Two: Are Hedge Fund Returns a Mirage?
  11. Part Three: Portfolio Matters
    1. Chapter 17: Diversification: Why 10 Is Not Enough
      1. The Benefits of Diversification
      2. Diversification: How Much Is Enough?
      3. Randomness Risk
      4. Idiosyncratic Risk
      5. A Qualification
      6. Investment Insights
    2. Chapter 18: Diversification: When More Is Less
      1. Investment Insights
    3. Chapter 19: Robin Hood Investing
      1. A New Test
      2. Why Rebalancing Works
      3. A Clarification
      4. Investment Insights
    4. Chapter 20: Is High Volatility Always Bad?
      1. Investment Insights
    5. Chapter 21: Portfolio Construction Principles
      1. The Problem with Portfolio Optimization
      2. Eight Principles of Portfolio Construction
      3. Correlation Matrix
      4. Going Beyond Correlation
      5. Investment Insights
  12. Epilogue: 32 Investment Observations
  13. Appendix A: Options—Understanding the Basics
  14. Appendix B: Formulas for Risk-Adjusted Return Measures
    1. Sharpe Ratio
    2. Sortino Ratio
    3. Symmetric Downside-Risk Sharpe Ratio
    4. Gain-to-Pain Ratio (GPR)
    5. Tail Ratio
    6. MAR and Calmar Ratios
    7. Return Retracement Ratio
  15. Acknowledgments
  16. About the Author
  17. Index