Twitter

There’s been a great deal of chatter in the business community about Twitter. To me, most of it appears to be excited businessmen smelling a hot commodity, but still struggling to understand what makes Twitter so popular. Here is an article where a businessman shares his insights by creating a parallel between Twitter/Facebook and the Id/Ego. Just the fact that he’s trying to force Twitter into an existing and familiar framework not only seems forced, but it’s a reflection of about 90% of the business thinking surrounding new ideas like Twitter. Too often there's a disconnect between a hot technology idea like Twitter, and the people with money to spend on these ideas. There is an inclination to squeeze these ideas into an old-fashioned business model, until profits oozes out.

This is a good summary article of how most business people view twitter. They outline 10 ways that Twitter will change business. I’m going to save you some time by telling you that there’s only about five unique ideas in this piece, the rest is just filler to make the list 10. The core of these ideas fall into one of two business advantages:

1. Corporations can gather personal data about people;
2. If people follow corporations, the companies have a direct channel to their consumer through tweets.
   

But when I read the article, I had an out-of-body experience that the year was 1993 and I was reading this exact same article, except it wasn't about Twitter, it was about a new thing called E-mail and the Internet:

1. “In utilizing the Internet, we are able to collect personal data from consumers about their preferences!”
2. “By collecting hotmail addresses we can use electronic mail to harass the customers about promotions and sales at pennies of the cost as regular mail!”
   

It’s really all the same stuff. There are definitely some good uses outlined in the article, but there’s no game-changer. Twitter, in-and-of-itself, is a minor connectivity improvement.

Then there’s Howard Lindzon, who has leveraged Twitter to create something called Stock Twits. Essentially, it’s designed to be twitter specifically for day-traders. Follow truth and rumours from the investor gurus in real time! I suppose this is an important step for day-traders, Twitter can help unify hundreds of different investment chat rooms into a single massive investment community. But I'm just not feelin' it.

But then I read this. It blew me away. The idea is that StreamBase Systems wants to collect and interpret tweets to determine if there is a particular sentiment towards a stock or the stock market in general. The challenge for them is to interpret all the tweets and organize that data into forming a collective sentiment.

The article goes as far as citing an old day-trading secret, which serves as a convenient example of how the power of this tool would manifest. Recall last week we discussed how markets are efficient, and that any news about a particular stock, or the general economy as a whole, is quickly incorporated into stock prices as soon as the news is made public. There is an old trick that day-traders use (which might have a slick short name that I am unaware of) called, “Buy on rumour, sell on news.”

For example, let's assume RIM is going to announce its 2nd quarter earnings on July 15th. Now, as day-traders we believe that RIM has a positive sentiment associated with it (by that I mean RIM is a good company, it gives investors a positive feeling because it often exceeds expectations). Because we believe this, we can potentially ride this sentiment to profitability. How? The way we can profit from this is to buy the stock early, and sell the stock right before the news about their earnings is made public, so in this case we would sell it July 14th. At the end of the day, we just have to guess which way the herd is leaning to make money. It doesn't actually matter if RIM has exceeds its estimated profits on July 15th - we're not actually betting on the stock; we're betting on the market's collective perception of the stock.

With StreamBase Systems data, we can potentially tap into a more accurate depiction of that sentiment. We can decide based on their data if the market is relatively positive on RIM, and make an educated guess about whether the price will creep up on anticipation of the Q2 earnings report. Investors will pay StreamBase for this privileged information, because in theory, it provides an information advantage on the market.

There are some potential loopholes here. If the service is truly good at depicting market sentiment about a stock, most or all day-traders will rely on it (heck - institutional investors will be all over this too). If most day-traders rely on the same source, it means they'll receive the same data at the same time, and will transact as a herd which eliminates their profit margin on the buys and sells. The other problem is information being leaked. Currently, I don’t have to read the Wall Street Journal to know what WSJ is writing about because bloggers and tweeters are writing about it for free – I just have to follow the right people and I can get my information for free.

But whether or not one can profit from this service is not why I found the article powerful in the first place. What fascinates me is the potential to interpret tweets and form a general sentiment. The idea of a collective consciousness was always said to be possible with the internet, but will Twitter be the application to make it a reality?

Back to School

Efficient Market Hypothesis (EMH). When our professors first introduced the concept to us in finance class, we were all blown away. Everything we knew about the stock market had been crumpled up and thrown into a waste basket in the span of an hour’s lecture. Although the idea lives primarily in classrooms, there’s no denying its power.

I noticed that instantly my classmates had either rejected the theory because it went against everything they knew and practiced, or they wholly embraced the idea like a new found religion. Nobody sat on the fence.

Wiki says: In finance, the efficient-market hypothesis (EMH) asserts that financial markets are "informationally efficient", or that prices on traded assets (stocks, bonds, or property) already reflect all known information, and rapidly change to reflect new information. Therefore it is impossible to consistently outperform the market by using any information that the market already knows, except through luck.

For example, as soon as RIM announces bad news, something like a product defect, the stock price drops before you can click on “sell” on your computer. By the time your order is processed you will have sold at a lower price, one that reflects the loss incurred by RIM. There are so many investors trading this stock around the world that that its price is perfectly efficient, given the information available at any point in time.

It doesn’t have to be company specific-information; it can be general economic news. For example, the stock price of a clothing store like the GAP can suffer from economic reports that state consumer spending is down and consumer confidence is low. It’s worked into the price by the time you hear the news. Retail stocks depend on consumer demand, the connection is real and the reaction is instant.

An extension of this theory is something called the Random Walk.

Wiki says: The random walk hypothesis is a financial theory stating that stock market prices evolve according to a random walk and thus the prices of the stock market cannot be predicted. It has been described as 'jibing' with the efficient market hypothesis. Economists have historically accepted the random walk hypothesis. They have run several tests and continue to believe that stock prices are completely random because of the efficiency of the market.

There is a myth that lives in finance textbooks about the Random Walk. We were told that in order to prove the theory, a scientist scattered some bird feed on the stock listings of the Wall Street Journal and allowed a pigeon to peck at the various stocks on the paper. Wouldn't you know it? The pigeon's portfolio provided a return equivalent to the overall market's performance! The idea is that fund managers don’t have any distinct advantage over me, you, or the bird. In the long run, the fund managers that invest in equities simply earn the same overall rate of return that the market earns.

It was easy for me to embrace this theory. Entering the technology stock boom, at least a third of the people in my program were playing the market. These kids could not stop talking about their stock picks. They were buying low and selling high, or sometimes buying high and selling higher. They couldn’t lose. I didn’t understand how a bunch of bright-eyed pimple-ridden adults were beating the market. But once I learned about the EMH, things clicked. Anyone trading stocks during that time was profiting from a very positive market sentiment.

[An aside: One reason students could get in on the action was electronic trading and online brokerage services had become mainstream. Before online brokerages, you had to hire a broker and the commission costs were much larger, which was a barrier to younger inexperienced investors.

Another important note about that time was not only how misunderstood tech-stock valuations were, but there were some aggressive accounting policies that made many technology stocks look much more attractive. So you had good ideas being sold as profitable ideas, which wasn’t always the case, and on top of that you had company management aggressively recognizing revenues, both of which made several companies appear more profitable than they really were.]

What EMH and Random Walk are saying is that during a boom like that, everyone wins. And when the bubble bursts, everyone loses (including the pigeon). Of course that doesn’t change the money that was made and lost. It just illustrates that there is a general wave the stock market roller coaster rides, and whether you get stock advice from a pigeon, whether you read about the market and do your own analysis, or whether you invest in a mutual fund where a professional picks the stocks for you, ultimately, we’re all riding the same wave, and our returns will average out to be the same in the long run.

But you see, the real benefit of knowing these theories has nothing to do with making money. It has everything to do with how you look when you make money. It’s like when you fill out an NCAA bracket and you end up winning the office pool and then you tell everyone that your girlfriend made all the picks for you.

Of course, investing gets more complicated than that, especially when we start to look at what hedge funds can do. But for people like you and me, and the pensions and mutual funds that invest on our behalf, the EMH simply serves as a reminder that you win some and you lose some. But most importantly, it assures us that there is no secret way to beat a pigeon at investing.

J.D. Salinger

I had completely forgotten why I’ve always wanted to be a writer. Over the years, I've just assumed that I always had an interest in reading and writing. Then I came across this. I remembered that it was actually one particular book that inspired it all.

Before I read Catcher in the Rye, my reading experiences went like this:

• The Hardy Boys (and other similar fiction series) were good stories but nothing about those books were special;
• I read Sweet Valley High in 6th grade simply because I knew it would bother my teacher who didn’t think I should be reading books like that because I was a boy;
• I read Lord of the Rings but it didn’t feel right because I skipped so many boring pages, and felt like I was just pretending to like it because everyone else liked it;
• In 7th grade I read Farewell to Arms by Hemingway and didn’t get it.
  

I had no idea what I was looking for until I read Catcher the summer before I went to high school. I quickly accumulated everything I could find written by J.D Salinger (the entire family: Franny and Zoey, Carpenters, the banana fish, etc.) I found several different occasions to re-read Catcher (normally squeezing some credit out of my English teachers for doing so). It was the only book I knew that got better each time I read it.

But it wasn’t until an English presentation in 12th grade where I decided to enter the classroom in character, as J.D. Salinger, and present his works to the class for my independent studies project, when I realized how obsessed I actually was with J.D.

Lucky for me, the internet had emerged by that time, and I quickly discovered I wasn’t alone. The question that haunted all of us was always the same: Why?

It tantalized me. How could someone that connected to so many people simply not care about his popularity? How could someone that wrote such a perfect book not want to write more?

The number of artists and writers influenced by him is astonishing. There are numerous attempts trying to extend his work somehow, trying to write the sequels, finish the Holden Caufield story, or tell Salinger’s story – for so many people J.D. Salinger is not a person, but an inspiration.

The only time you ever hear about J.D. in the news nowadays is when he is fighting to protect the unique existence of Holden Caulfield in the locket that is Catcher in the Rye. There is actually a "legal conflicts" section in his wikipedia page, if you're interested.

It’s my dream to create something, just one thing that people of my generation would hold dearly to their hearts. Now that I’m all grown up, I don’t really think about the “why” anymore. I understand it completely. Jean-Paul Sartre described this concept as the "ultimate goal,” a singular objective that an individual strives to achieve. It is the sole creation that justifies all the steps needed to create it. It is a lasting impression left on earth that justifies all the coffee, cigarettes, and sleepless nights.