Lies, Damned Lies … and Statistics!
Updated: Mar 26, 2021
There are three types of lies: lies, damned lies and statistics! This phrase was popularised by Mark Twain and describes the persuasive power of numbers.
Investing in stock markets and especially trading in it requires the use of statistics. The two broadly used analyses by stock market experts are fundamental and technical analysis, both of which use statistics as their main tool to analyse and determine the intrinsic value of the stock.
In fundamental analysis, the most commonly used tool is the price to earnings multiple of a stock. It is calculated by dividing the earnings per share by the current market price of each share. Experts want to buy the stock when it is running at a low P/E and want to sell when it is high. But the hidden aspect over here is that, the earnings used are the earnings that have already been earned which mean that the stock price has already reflected the positive or negative effect of it thus negating the use of the multiple. But the use of statistics makes the stock look attractive!
In technical analysis, market technicians use charts to determine points of entry and exit of the stock markets. Now, if you see there are infinite ways to chart points on a graph ranging from historical market prices of stocks, using candlesticks to using various mathematically absurd averages. Out of these infinite charts, at least one would surely be there for the technician to prove his/her point. The truth is that the charts speak the technicians’ words whereas it should be vice-versa!
Let us take another example and suppose that the price of stock X is Rs. 500. In the course of the year the price falls by 50% to Rs. 250. Now, the investor would feel that only 50% has fallen and he would recover the lost 50% in some time. But what he doesn’t understand is that, the stock would need to bounce back by 100% (250*100%=250, 250+250=500) to come back to square one.
These points prove how statistics can be the attractive mask hiding the real picture. It may not be a lie but I may certainly call it a euphemism for a lie.
With all due respect to statisticians and stock market experts, I suggest you don’t pay much heed to their attractive and window dressed ways to convince you for short term trading. And if you still don’t agree with me then remember that in investing money, the amount of interest you want should depend on whether you want to eat well or sleep well!
Be a long term investor and just enjoy the ride…