Tuesday, October 16, 2012

A Mathematician Plays the Stock Market

In the late 1990s, it seemed like everyone was a stock market expert. This was fueled by the fact that it didn’t matter much which tech stock you bought because almost all of them went up. Even mathematician John Allen Paulos got caught up in the hype with WorldCom stock. In his book, A Mathematician Plays the Stock Market, Paulos weaves a humble story of his investing folly along with many understandable mathematical lessons about investing.

Like many “investors” at that time, Paulos abandoned good risk management and “invested heavily in WorldCom, as did family and friends at [his] suggestion.” He even “emailed Bernie Ebbers, then the CEO, in early February 2002 suggesting that the company was not effectively stating its case and quixotically offering to help by writing copy.” Of course, the world later found out that the real problem was “creative accounting” rather than poor marketing.

On index investing, the author makes an interesting point that despite the fact that it “generally beats the more expensive, managed funds,” investing in an index fund has a cost: “One must give up the fantasy of a perspicacious gunslinger/investor outwitting the market.”

On online trading, Paulos said “The ease with which I clicked on simple icons to buy and sell ... was always a little frightening, and I sometimes felt as if there were a loaded gun on my desk.”

There were a few not so good parts of the book, but they didn’t take away from my enjoyment of it. The author claims that the S&P 500 index suffers from survivorship bias, but I don’t think this is true. In a couple of places one of the numbers in the Fibonacci sequence is wrong. In a numerical example about compounding, one of the amounts is off by a dollar.

Overall, I thoroughly enjoyed this book and recommend it to anyone who would like clear explanations of investing matters without too much mathematical jargon, or anyone who would enjoy reading about a smart guy admitting to all of the dumb things he did while trying to get rich in the stock market.


  1. Years ago Financial Times run a article about education in investment. Professor who taught the course started it by offering his students a simple bet: he offered a reward of $100 to the student who will manage to state a number between 0 and 100 that will be 30% lower than the average of all numbers stated by other students; everyone had to make their bets secretly, then all bets were to be compared.

    This simple process illustrates how stock market works: it's not about reality, it's about people's perception of reality. All math is needed only to forecast other people's perception.

  2. @AnatoliN: That is a very good way to illustrate the challenge of predicting what others will do while they are all trying to predict what everyone will do. I find it interesting that in the short term, market prices are driven by these mind games, but in the long term, market prices are driven by business performance. This is why I think long term and avoid playing the game of guessing what others will do.