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April 30, 2005 The Quantum Stock Market |
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In response to a student's
concern about the risk associated with investing in the stock market.
I think that stocks are like Quantum mechanics. Quantum mechanics tells us that the direction and momentum of any particular particle is unpredictable. However, the direction and momentum of a macro object, which is made of trillions of unpredictable particles is very predictable. In investing this concept is called diversification. Historically, over the long run the stock market produces returns of approximately 10 percent per year. If you have a diversified portfolio and hold it over many years, it is very likely that you will do well. On the other hand, if you are day trading, when you bet that a stock will go up, you have to find a seller who is betting that the stock will go down. Likewise, to sell a stock, you have to have someone on the other side betting that the stock will go up. Assuming that you do not have insider information (which would be illegal) you have not better information than your trading partners, who are betting in the opposite direction. This is why it is so hard to make money day trading. I am also reluctant to take advice from many stock brokers. Brokerage houses own an inventory of stocks. When a brokerage house wants to unload a particular stock, many of them will increase the commissions that they pay to brokers for selling that stock. In other words, when a broker advises you to buy a stock that advice may be driven by the brokerage house's decision to sell that stock.
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