in the dealing room. Looking at the prices flashing on the screen, I wondered if the market reaction was very long lasting. Sure enough, my subsequent research showed that while falling currencies typically bounce after government action, in less than a month or so, they resume on their downward path and continue to weaken towards fresh lows.
So by spotting this pattern I had found a new, profitable strategy. Whenever the market had this kind of knee-jerk reaction to government intervention, I would bet against it, on the assumption that the bounce was only temporary. I was effectively backing market fundamentals versus the government.
The fact that even governments, with all their muscle, cannot reverse the market has always impressed me. It shows the depth and efficiency of the financial markets.
Keep that in mind when you think that the market price is wrong.
1.5 The market is strengthened by speculation
Over the years I have heard a great deal of criticism about speculators. It often pops up when markets or currencies are having a dramatic fall. Funny, speculation doesn’t seem to bother so many people when it’s pushing prices higher. Should speculators be ashamed? No, the fact is that the market needs them.
Speculators add important liquidity. I often invest in small stocks, which would not have much daily turnover if it were not for speculators. The longer term holders of these stocks do not buy or sell very often, so when I need to find a buyer or a seller, it is a great benefit to have speculators as they are much more active.
Speculators also play an important role in absorbing risk that others don’t want. Wheat farmers, for example, may sell their crop well before harvest at a fixed price for a future delivery date. That way, they can remove the risk that there is a bumper season and an oversupply that forces prices lower. The buyers may be speculators who are happy to take on that risk – without the speculators, the farmers may have no one to sell to.
You often hear criticism of speculation based on the flawed argument that it pushes prices to unrealistic levels. The thing is though, speculators are usually punished when they do this, because if they are wrong about real values, they are usually the big losers. The tech boom and bust, where perhaps it was speculators who drove prices to very high levels, is a great example. Most of them paid very heavily when market prices crashed to a fraction of the higher levels. Though what a great opportunity it was for the more savvy investors to sell near the highs.
So, speculation is usually only successful when it is in line with the fundamentals, and when it is pushing prices to a level that more closely reflects fair value.
George Soros and Black Wednesday
A great example of this is George Soros. He has been criticised because his massive selling probably caused the devaluation of the British Pound in 1992. In fact the resulting weaker currency and lower interest rates saved the UK economy, because they were more appropriate for the conditions at the time. The date (16th September 1992) is known as ‘Black Wednesday’ because the currency was pushed out of the European Exchange Rate Mechanism (ERM), but in my view it should be renamed ‘White Wednesday’. That day is one reason that the UK has only five per cent unemployment, while Europe, which stuck with cripplingly high interest rates for way too long, has about ten per cent. The feeling was that Soros was a greedy speculator who made a billion pounds in profit, but in fact it has proved to be a very cheap price for the British, because the lower pound - and the resulting lower interest rates - allowed for a big improvement in the economy. If the man in the street knew how things worked, Soros would be seen as a hero, not a villain!
For this reason, many commentators are naïve when they criticise these price shocks and the speculators involved. It can be better to have wild swings in currencies and other prices than lots of people losing their livelihoods.
It was a similar case in the late 1990s, when Malaysian Prime Minister Mahathir attacked currency speculators because they were pushing down the value of his currency. Again, speculation wouldn’t have worked unless there was a solid reason behind it. A few years later, the consensus is that the currency was too high for the economic conditions at the time.
The speculator is often just the messenger.
1.6 Respect the market not the experts
The power of the financial markets should be daunting, but many people are not deterred.
I have friends in Monaco who are amateur currency traders. They don’t have the same experience, resources, or the skill, of a George Soros. Nor do they follow the disciplined approach to trading that is recommended in this book. It’s completely crazy that they think they can win. Why do people underestimate the difficulty of making money in the financial markets? I believe there are two main reasons.
The first, which I will discuss here, is the experts in the media. The second is the widely held belief that many professionals are regularly able to beat the market. This I will discuss in the following Strategy. I won’t dwell on a possible third reason, which is that some people like to trade the market because they are gamblers. That usually ends with disastrous results.
‘Experts’?
The experts in the media promote the idea that markets are easier than they really are. A guy on TV or in the newspaper says that the price is going to do this and do that, and it sounds easy. The market can be beaten.
If the media put out a continual broadcast that the market has processed all the information and that the price is right, people would get the message. But they rarely say that. The message is that the behaviour of the market can be forecasted. It’s a persistent and seductive message, and people think ‘ah, I can have a go at that, I can make money out of that’. You can’t blame the average person for following what they read in the newspaper and what they’re being told on TV. However, many so-called experts are just commentators or analysts who often don’t have any track record and who often, to my ear, don’t even make much sense. Follow my advice below and listen critically, rather than just accept what you’re hearing or reading. You may be surprised to find that they’re not really experts.
Not that I blame the media for their financial guesswork. It can be very entertaining. But like a lot of gossip, the fact that it’s entertaining and interesting doesn’t necessarily mean that it’s the truth.
1.7 Most professionals are not outguessing the market
You may heed my early warnings that the markets are difficult and that the media underplays the difficulties, but you may also wonder about all the money made by the people working on Wall Street or in the City of London. Surely they know something about markets?
Let me put you straight on this. The truth is that very few are successfully backing their views on markets. Most of them wouldn’t have a clue what the market was going to do. They make money in other ways, such as commission and management fees.
It’s not that people working in finance don’t know anything – they are usually very good, very smart people. I respect a lot of them and many are my friends – but the fact is they’re making money out of sales, client relationships and by doing transactions, i.e. facilitating the whole process. They’re not actually making money out of successfully predicting what’s going to go up and down. They are, therefore, not a reason for you to take up punting cotton futures in your spare time.
Equally,
