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Wednesday, September 19, 2012

Just Close Your Eyes and Swing

“Taking investing advice from a Wall Street firm is like getting hitting tips from the opposing team’s pitcher.” Michael James
Years ago I thought I understood the mechanics of investing. You had a broker at some big financial firm who took your trades and gave you advice on trading stocks and bonds. The first time I found out that these same firms also have people who do trades with company money, I couldn’t understand how this could be anything but a huge conflict of interest. But, I assumed that I just didn’t understand some critical aspect of this relationship.

Enough time has passed that I now realize that I wasn’t really missing anything; there is a conflict of interest. There may be rules or laws intended to prevent abuse, but there remains an incentive for financial firms to advise their clients to trade the opposite sides taken by their internal traders. For example, if the company is trying desperately to unload a pile of XYZ stock they believe is about to tank, one way to find enough buyers is to advise their clients to buy XYZ stock.

Given this misalignment of interests, why do so many people take investing advice from financial firms that trade on their own accounts? How do they tell whether they’re getting the investment equivalent of “just close your eyes and swing”?

2 comments:

  1. Hmmm, this insight leads to a contrarian strategy. When a broker calls, simply take the opposite of the recommendation. He says buy, you short. This will confuse and demoralize your broker, so it's really a double win.

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  2. @Gene: This would probably work nicely if your broker is consistently steering you the wrong way. So, you need to get the least scrupulous broker you can find to make this work :-)

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