Posted on September 5, 2008
Filed Under Web 2.0 Kool Aid |
I’ve always been somewhat amused by social investing websites like Cake Financial and Covestor. As someone who trades stocks and options for more than just fun, I have always believed the utility of services that look to help amateur investors by sharing the portfolios of their members and tracking results is minimal.
While a detailed discussion of my beliefs is beyond the scope of this blog and would be boringly technical, I found a good way to address the subject by using the announcement of Cake Financial’s new index fund - .
The Cakedex is “an index of the top 100 holdings of the top performers on Cake.” In the near future, the Cakedex a real index fund that investors can purchase.
Cake Financial touts that over the past five and half years, the Cakedex would have outperformed the S&P 500, the Dow Jones and the NASDAQ.
Fair enough - if you’re willing to ignore the fact that the bull market which ended this year started in 2003, making it possible for even monkeys to make money over the past five years (and many of them did).
But beyond this, there’s an important fundamental question - why would any amateur investor want to put money into a hodgepodge index fund whose holdings are based solely on the portfolios of a small number of unknown individuals who have supposedly done well by Cake Financial’s measure?
What knowledge and experience do they have? How have they performed in different kinds of markets? What rules and investment strategies do they adhere to?
Without answers to these questions, putting money in a Cakedex index fund is going to be a lot like giving money to a class of third graders and asking them to buy stocks with it.
To demonstrate this, I decided to look at some of the components of the Cakedex today.
Google (GOOG) makes up 2.63% of the Cakedex index this month. But it’s in a clear downtrend. The chart below is not one that an experienced trader trades long yet GOOG been in the Cakedex since May.
Washington Mutual (WM) has come off of its July lows but the chart is pretty clear - this is not a time to be long unless you’re trying to call a bottom (which you don’t do).
Why has Yahoo (YHOO) been in the Cakedex since May? With all of the Microsoft drama, YHOO wasn’t a stock for amateurs to “play” given the fact that it was a highly visible target for large institutions that like to “fool around.” And for those who traded YHOO in may, the chart made it clear by June that this wasn’t a stock worth holding long.
Potash (POT) is a stock I know extremely well from my own trading. It has been the beneficiary of commodities boom and the impressive uptrend seen on a one year daily chart shows this quite spectacularly. Although its underlying fundamentals are solid in my opinion, POT broke through the neckline of a head and shoulders formation recently, signaling a reversal. And as much as I like the company, a good company doesn’t always make a good investment and this turned into a short trade real quick, not a long one.
These are but a few examples I found of stocks in the Cakedex that break very simple and very basic trading rules. From oil companies to gold to financials, there is no shortage of Cakedex holdings that are fighting today’s market forces - and it took less than 15 minutes (and some very sloppy trendlines) to spot them.
Of course, it’s fair to point out that not everyone “believes” in technical analysis. But you can be sure that the traders at major institutions who are in business to take your money are paying attention to technicals and what I’ve done above isn’t anything more complicated than looking at a chart and drawing a line with a ruler. There are no special indicators other than price and price never lies.
It’s also fair to point out that people will say, “But Drama, buy and hold is a good strategy over the long-term. These stocks will come back at some point.”
Yes, everyone wants to believe that they’re a Warren Buffet even when it’s a bit more complicated than that.
In my opinion, buy and hold often equates to a hope and a prayer - especially in a market like this. I don’t advocate that the average investor trade day in and day out, but by looking at a one year daily price chart, drawing trendlines and recognizing common chart patterns, individuals can not only keep themselves out of bad new trades, they can exit existing ones before they turn bad.
Fewer bad new trades leads to lower losses and timely exits lead to maximized profits. What’s wrong with that? Nothing, unless you like sitting on losses and letting gains evaporate.
Unfortunately, I see no evidence that the best of the best on Cake Financial as reflected by the Cakedex index are anything more than amateur investors who don’t know what they’re really doing.
And the recent performance of the Cakedex seems to confirm that. The index lost nearly 10% in June, 8% in July, .15% in August and is down over 6% this month thus far.
For those keeping score, that’s almost 25% in less than 4 months. Painful.
At the end of the day, the Cakedex is an interesting novelty but not much more than that. If you’re looking for the wisdom of the crowd in the stock market, look at a price chart, not a social index fund.
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