Even a mathematician can be grabbed by the psychology of gambling and make losses on stock markets despite maths telling him that prices are unpredictable.
He Figured the Odds and They Still Beat Him
John Allen Paulos is Professor of Mathematics at Temple University and writes on a wide range of topics that put mathematics into everyday contexts. A Mathematician Plays the Market considers both the psychology of playing the financial markets and the possibilities of predicting price movements using mathematics and other quantitative methods.
The thread that runs through A Mathematician Plays the Market is Paulos’ losses on WorldCom and his flawed investment approach that he adopted in the face of his mathematical understanding. He got sucked in like many gamblers by the psychology and failure to read the signs and act accordingly. He is entirely candid about his losses and his delusional thinking as he explores each aspect of the mathematics and the psychology of playing the markets.
Exploration of Mathematics and Psychology of Playing the Stock Market
A Mathematician Plays the Market examines many assumptions and analytical approaches used by financial professionals and other investors to develop their investment and trading strategies. The chapters focus on those assumptions and techniques and test them for mathematical validity.
- Anticipating Others’ Anticipations – examines whether stock markets are about guessing what other people are going to do rather than what the fundamentals suggest the market should do.
- Fear, Greed and Cognitive Illusions – Explores the psychology of investing and why thoughtful people, like the author, still make elementary mistakes.
- Trends, Crowds and Waves – Technical analysis is essentially flawed in a random market except for following the followers.
- Chance and Efficient Markets – Challenges the efficient market and using probability for tip-sheet scams.
- Value Investing and Fundamental Analysis – Shows how an understanding of the discounted value of future money is needed for fundamental analysis and its flaws.
- Option, Risk and Volatility – Puts risk in its proper place and how to use options to mitigate potential losses rather than to increase gearing.
- Diversifying Stock Portfolios – Explores portfolio diversification as a means of mitigating risk.
- Connectedness and Chaotic Price Movements – Further explores the unpredictability of stock markets especially with regard to chaos and extreme price movements.
- From Paradox to Complexity – Shows how efficient markets and sluggish market theories are inherently paradoxical. If they are true then Paulos shows how they are then of no use in trading.
A Good and Accessible Read – Provides Essential Understanding for Serious Investors
A Mathematician Plays the Market is an enjoyable read but it falls a little between two stools. Although the mathematics is not particularly complex many readers and would be investors may be put off by the mathematical concepts. It is well explained in, mostly, plain English and that may make it less comfortable for the mathematically competent who would prefer the arguments to be laid out and explained using the efficient, at times elegant, language of mathematics. But anyone who has investments in the stock markets should read this book; even, perhaps especially, those whose investments are "professionally" managed through their pension or other managed funds
Traders and other investment professionals may gibe at the conclusions but they need to bring the same rigour to any refutation of Professor Paulos’ arguments.
Investors would be well advised to read A Mathematician Plays the Market and take on board Professor Paulos’ guidance to managing risk and accept that the market is inherently unpredictable especially with regard to short and medium term price movements.
A Mathematician Plays the Market, He Figured the Odds. And they Still Beat Him (2003, ISBN: 978-0141012032 ) by John Allen Paulos is published in paperback by Penguin at £9.99.
First appeared on Suite101