Why your securities exchange expert may not be of much use

 

A Nairobi Securities Exchange employee monitors trading on the electronic board. Rolling the dice to randomly select which stocks to buy actually beats the advice of investment banks and stock brokers. PHOTO | FILE 

By SCOTT BELLOWS

In Summary

• Studies show that trading stocks based on your analysis cannot make you perform better than other people.

Munyao slowly walked through the Maasai Market at the Village Market in Nairobi. Suddenly he spotted an African-print scarf selling for more than 20 times the price that the same item is sold for in Gikomba market.

Initially stunned at his discovery, Munyao elatedly hopped in his car, braved the Nairobi traffic, and drove over to Gikomba market to buy as many of the same African-print scarves as possible.

Munyao snatched up scarves from every supplier he could find yielding a total of 45 pieces. He then secured a spot in the next Maasai Market at the Village Market and began selling the scarves.

He giddily racked up huge profit margins during the next two Maasai Market days.

Unfortunately for Munyao, by the third Maasai Market an additional seller began selling the same scarves for only 18 times the price sold in Gikomba. By the fourth Maasai Market another seller sold at 17 times the purchase price on the other side of town.

Customers too started to comment about other locations where they could obtain the scarves at cheaper prices.

Eventually, the scarf price at the Maasai Market at the Village Market dropped to less than two times the Gikomba cost, which only narrowly covered the transport cost between the two locations.

Munyao experienced the joys then disappointments of arbitrage. Large price differences in the market face pressure to close the gap with the ebbs and flows of supply and demand.

Since everyone desires a profit, price disparities do not last long. In the above vein of thought, we continue the Business Talk mini-series on investment decisions.

Like Munyao’s arbitrage dilemma, many investors in public equities strive to root out and then exploit gaps in stock, bond, foreign currency, commodities, derivative prices, etc.

However, imagine Munyao’s scarf example magnified exponentially with millions of the smartest people in the world emboldened with brain power, networks, and proprietary computer software all trying to uncover incorrect or inconsistent prices in public securities.

Instead of several weeks of Maasai Market days, such price compulsion instead occurs in nanoseconds.

Unfortunately, an experienced stock trader finds it laughable when a novice investor looks at gross margin differences between two similar firms, like Barclays Bank of Kenya and Kenya Commercial Bank, and thinks one of the stocks is undervalued and then decides to buy the stock.

When both banks’ financial statements got released, thousands of other investors already noticed the margin difference and the stock price for the poorer performing bank changed immediately as investors demanded less of the stock.

A novice or student who finds the difference weeks or months later would not benefit from the margin knowledge in any way since the stock price already corrected to reflect the new margin information. In stock markets, knowledge based on new information occurs almost instantly.