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Economic “Assumptions”

Economic “Assumptions”

The Economics of investments get lost in the “assumptions”!


Greetings fellow traders, financial enthusiasts, and general members of the public,

Several years ago when I took my first finance class at Georgetown University’s School of Business I vividly recall learning about what is known as the Capital Asset Pricing Model (“CAPM”).  This model was, and still is widely used to determine the value of taking on additional risks in a portfolio (represented in this model as the “beta” of a financial instrument).  

My intention here is not to elaborate on the mathematical formulations of models such as the CAPM but rather to highlight many of the assumptions that expose the frailties of economics, and fundamentals, when they are categorically implemented for the purpose of  adding value to a portfolio.

There is an old humorous explanation of the use of economics when it comes to practical solutions.  The crux of the story is as follows:  Three men are stranded on an island.  One of the men is a physicist, another is a chemist, and the third man is an economist.  On the island there is only one can of beans that are in a sealed container that they need to open in order to survive.  The upshot of the story is that the physicist and the chemist explain, in turn, elaborate yet practical solutions for opening the can so they will not starve.  The economist, with all of his wisdom, simply replies:  “Let’s assume we have a can opener.”  

Practical solutions must be applied to any successful trading endeavor, and though the “art” that is involved in successful trading will be saved for another day, value is the most important cornerstone to long term success.  This is true regardless of the type of financial instrument that is involved. 

Even though the markets that The Futures Wizard analyses involve much shorter duration’s than the typical stock (equity) investment portfolio, the import of value is as preeminent in leveraged markets as it is in any other type of investment.  Even though the markets always dictate what prediction The Futures Wizard disseminates, practical value is always an imperative part of the equation. 

While it is a certainty that the knowledge of pricing models such as the CAPM, discussed above, assist in identifying value added market positions, assumptions are limited in their ability to extract the practical information necessary for consistent value added results.  In essence, Michelangelo and Sir Isaac Newton are more valuable than Keynes or Friedman in this regard.   

Dear traders, successful trading is indeed an art as well as a science.  Massive experience and the ability to extract the “art” from the “science” are necessary elements to obtaining trading wizardry.

We hope you have the Wisdom to Trade like a Wizard! 

All the best,

Jack-  (Senior editor- “The Weekly Wizard”)

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