Book Review: How Markets Really Work: A Quantitative Guide To Stock Market Behavior

Includes: BB, NFLX, SODA
by: Robert Weinstein

Those who follow my trading can tell you quickly what type of trader I am. I fade primarily overbought markets and occasionally buy oversold markets. My real focus is stocks as there are simply more opportunities in a universe of thousands of stocks compared to maybe 100 other products with any real liquidity.

Fading gets a bad reputation from so many who refuse to let go of a position moving against them as they try to "average into" or "dollar cost average" a loser.

This is not the same as fading an emotionally charged rapidly changing price, but rather emotion taking over control of what may or may not have begun as a logical start. Laurence Connors and Cesar Alvarez bring forward How Markets Really Work: A quantitative Guide to Stock market Behavior Second Edition 2nd Edition (Bloomberg Press - Wiley)

In some ways I have mixed feelings about a book like How Markets Really Work getting published. Connors and Alvarez lay out in such simple terms a historical long term profitable investing strategy that basically anyone can follow. With investing there are no guarantees and anyone who has been in the trade for long enough knows markets change. What veterans also know though is that people don't change. As a result the biggest changes in the markets in the last 50 years are technology and not any meaningful change in market participant reaction to earnings, war, peace, FDA decisions, and of course the FED. With so many strategies demonstrating a mathematical edge over time anyone with a computer can take the information gathered by studying How Markets Really Work and have a massive head start that may lead to financial independence and also more competition for me.

Fading is a winning strategy. Based on the data used in making How Markets Really Work buying weakness and selling strength may not really feel natural to those who use the main stream financial news media for guidance, but the profits will feel very real. Connors and Alvarez provide example after example of different time frames with different setups that are backed with charts and resulting data. Moving beyond the setups the authors also provide all the exits too. If the markets continue as they have and I see no reason in the long run why the financial markets will change as long as people make the final decision, there are no longer excuses for underperforming the market. Connors and Alvarez have simply taken away any last hope of providing an excuse to not one up your neighbor in the long run.

Beyond on the entries and exits provided, even perhaps more important is the shattering of the idea of buying into strength and selling into weakness are the only correct ways to make money in the markets. The "hot stock pick" that is going to the moon may not be such a hot pick when you're the last person standing in line to get on the bus. We have seen what happens when people chase stocks and it's not pretty to the portfolio or the ego.

It's not hard to picture what the portfolios of Netflix (NASDAQ:NFLX) buyers look like that chased the stock up on the top of the move. This new second edition has Netflix as an example inside. If you watch and or trade the VIX, there are examples using the VIX as well. Research In Motion (RIMM) and recently Soda Stream (NASDAQ:SODA) have also provided great examples of "what goes up must come down". What this book does is take exact setups and exits and presents the data.

If I had to sum up why this book should be read I would say that this book is not meant to be read, but rather studied. Upon paging through How markets Really Work it will become quickly evident that there is not a lot of pages wasted in filler text that doesn't say anything. What Connors and Alvarez say they say quickly, simply and without disrespecting the readers time. The ideas while new and in the face of conventional wisdom, reach out and grab your attention the first time without lack of clarity. The data provided in table after table provides new and exciting ways to extract edges few others tread upon. Within hours of finishing the book I was applying the concepts to other instruments like options to enhance gains while mitigating risk. Do yourself and your portfolio a favor. Pick up a copy and read this book from cover to cover. Then dedicate some time to studying the tables and graphs provided. Get excel "sheet1" in front of you and your scanning computer to look for yourself in ways that you can profit. Word for word, this may be one of the most profitable books you will read and earns a spot in my recommended book list.

Disclosure: I am long RIMM.

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