Money Matters: The best investment book of 2011

By Terry J. Diehl The Daily Record Newswire In gathering research for this article I was struck with a daunting idea: Why not read the top investment book of 2011, and report my findings here? The book is "Far from Random: Using Investor Behavior and Trend Analysis to Forecast Market Movement" by Richard Lehman. It was voted number one by Jeffrey Hirsch and Yale Hirsch of The Stock Trader's Almanac. As you can surmise from the title, Lehman takes issue with Burton Malkiel's "A Random Walk down Wall Street." In many of the university and financial training centers this has been the belief -- that no one can predict the market at any time; market movement is chaotic, random and entirely unpredictable. Lehman starts out with several stock market patterns that are totally contrary to the "Random Walk" theory: * There are six consecutive months that have dramatically outperformed the other six (Nov. 1 to April 30); * The last two years in a presidential cycle are far superior over the first two years; and * The first days of the month for past 153 months (start September 1997) DJIA (Dow Jones Industrial Average) gained 5,173.23 points. Average percent gain: +33.81 percent; the other 3,034 trading days lost 1,643.82 Dow points. Average daily loss: -0.54 percent. Lehman's point is that traditional Wall Street fundamental analysis fails in determining the "fair value" of a stock. Human emotions play a large role in the pricing of stocks. Lehman cited an example in 2008 that the fundamental analysts kept assuring the public that "stocks were cheap" as the equity markets plummeted. The market technicians, who base their decisions on the technical parameters, were either out of the market sitting in cash, or shorting the market, because that is what the technical trends indicated. The Wall Street adage says "it's a market of stocks;" he proposes that it is "a market of people" driven by human behavior, if not moreso than financial or economic factors. It is the behavioral factors that make us less than rational that give us insight into market predictability. There is a complete field that has evolved: behavioral finance. When CNBC speaks of "they," it refers to us. We set the prices by our willingness to buy or sell -- more often than not -- is not based strictly on the financial fundamentals, but on human emotions of which we may not be consciously aware. There were several interesting parts on how we arrive at certain decisions and the thought processes behind our internal logic, or neural shortcuts. This study is technically referred to as Heuristics. A part of this study is how the markets hate uncertainty and ambiguity. We, as investors, are willing to accept a lower level of performance in return for a greater amount of certainty. Other examples are: -- Anchoring: Placing a mental stake in the ground as a reference point. People tend to anchor to a recent stock price or range; -- Affect Heuristic: The tags that people place on complex judgments. An investor may feel that Google is new and exciting; IBM is old and boring; -- Belief perseverance: Once an investor tends to make a decision; evidence shows he tends to stick with it and defend it; -- Disposition effect: Studies have shown that investors are heavily biased in favor of disposing of an asset to realize a gain and against selling to realize a loss: -- Endowment effect: Investors demand much more to part with an object than they would be willing to pay for it; and -- Haloing: Tendency of people to extend a virtual halo around a person, organization or company that they like. A trend is familiar to most everyone, a general direction. Trend channels are two parallel lines that form a boundary above and below the data for a given time period or parts of it. Lehman has based his trend lines on price, rather than earnings. The technical analysis is quite detailed, and one should study the book for the exact description. The author has been placing his charts for the past five years free of charge on the Web at Stockcharts.com. Lehman admits that his trend channel analysis has some flaws, but it dramatically increases the odds for success. This book proved far more interesting than I initially thought, especially the chapters on human behavior and Lehman's background in both marketing and options trading, and the people he met along the way, especially Dr. Tom Stanley who authored "The Millionaire Next Door" and Robert Prechter of Elliott Wave Theory. ---------- Terry Diehl is a vice president for Karpus Investment Management. He can be reached at (585) 586-4680. Published: Thu, Jun 9, 2011