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The House Always Wins

>> Monday, January 7, 2013

A new year represents new beginnings and new hope. It is also a time to reflect on past lessons, to look forward wiser.


Recently, an article about the interview with Warren Buffett caught my attention and his comment about transaction charges particularly left an impression.

The logic is simple. Transaction based Companies are in the business to of making revenue by the number of transactions made. Similar to insurance sales, the prestigious Million Dollar Round Table (MDRT) is based on the number of new business sales brought in. Similar also to property agents whose main revenue is made by transactions closed and gets nothing if no deal is made. Hence, how can their emphasis be on getting the highest price for sellers and lowest price for buyers? Brokers are paid based on the number of trades carried out and not based on the net asset value the clients are holding.

This represents a conflict of interest between “advisers” and client. Investment banking firms provide the advice to keep trading, buying and selling, generating a lot of transactions and it is reflected by the amount of liquidity in the market. The quote I like from Buffett was that it was harder to purchase 10% of land in Nebraska over 3 years than it is to purchase 10% of IBM over 3 months. I think this applies to Singapore as well.

It does not help that there is so much proliferation of technical trading. Encouraging many to trade for a living, doing short term flipping based on indicators to generate an income. This is normal based on the human instinct of greed, hoping to make a quick profit with little or no effort, simply by following magic indicators that seem to miraculously predict the future based on past performance alone as illustrated by the gurus' numerous past results examples.

However, the overall winners are the dealers. As the saying goes, the house always wins, which is why the bookie industry is as lucrative as ever. Imagine a simple coin flipping game that is absolutely fair, 50% chances of either head or tail. However, the catch is if you wish to join in the game, you need to pay a 10% transaction charge. The long term probability is 0.5*(-110%) + 0.5*(90%) or even ignoring the complicated formula, a net loss of 10%. The losers compensate the winners and the winners compensate the house. Everyone loses except for the house.

When some of these brokers give advice, I sometimes feel like they are giving advice equivalent to the casino showing the trends of opening big or small in the dice games. You feel powerful thinking you have the knowledge and edge for winning. Right, it has opened big ten times; it will surely open big now. If only gambling and trading were that simple.

This is also timely to mention, having read that MAS FAIR review has concluded a "no go" for fee based advisory after so much hype. So, it is back to commission and the conflict remains. Talking big about a major revamp, causing much up roar in the whole industry for a year and conclude that little is going to change. Well, the official statement is yet to be seen, however, I am not too optimistic on its outcome to benefit the customer having confirm that fee based is out of the picture.

Happy New Year! Huat Ah!

2 comments:

CreateWealth8888 January 7, 2013 at 10:33 PM  

Those who teach people how to trade for living is better than the House and they don't even need to bother about the odds.

Lau January 8, 2013 at 8:38 PM  

That is not apple to apple. They have their own odds of people complaining and odds of people not joining their courses, etc. But they still win like the House in the end.

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