No Random Walking!

Following the rumor of Tom Group's buying Sina and the breakout in SINA's share price, the saga continues. More players are allegidly involved, as reported in Sohu's web site (isn't it ironic that the SINA's biggest rival is dedicating a full coverage on the rumor?). Even Google is said to be interested in at least a piece of the fat meat.
Sina is making me richer, but I really feel sorry for the company.
Updates:
[4/14/06] VC Michael J.G. Gleissner has acquired 6.4% stake in SINA.

Analyzing a stock chart is equivalent to analyzing a well log. In fact if you rotate a stock chart by 90 degrees, you will get something very similar to a well log.
Well logs are very often the closest information we can get about a reservoir thousands of feet downhole. Similarly the stock charts, i.e., its price and volume data along with the other charts derived from these data, are very often the most direct information about what's happening to the stock, from while we can then make extrapolation on what's likely to happen to the stock price in the near future.

The recent chart of SINA, above, is a very good example of showing the value of reading charts. The time period that I call "T2" is the most interesting. The candle-sticks, its relative strength chart and the CMF chart all leads to the conclusion that, for some reasons, SINA is under accumulation in spite of the weak earning guidance for the next quarter. It could have been due to its red-hot, though free, blog service it just released. A week later after the breakout ("T3"), it was reported that another Chinese Internet company, Tom Group of Li Kaching, is to acquire Shanda's 20% stake in SINA. No wonder!
In log analysis, we identify where the oil or gas is. In stock chart analysis, we identify where the money is flowing to or out of. Both are technical analysis and, when used correctly, adds value to an investment portfolio.

Anticipating a tough year or years ahead for the stock market, I am now trying to manage my personal

portfolio as a hedge fund, more specifically a small long-and-short equity type fund. The purpose is to hedge against a possible sudden market melt-down and, in more normal periods, to improve the overall return. My goal is to maintain a long/short ratio at a more-or-less constant level, say 70/30, but it will take some time to get there because most of my accounts are restricted (from shorting).

Chart above shows the historical performance of hedge funds (dark-green and blue) vs. $SPX (purple). Source: Credit Suisse/Tremont Hedge Fund Index. Note the lowered volatility, especially during the bubble-bursting years in early 2000s.

As someone who've spent over ten years in the oil industry, I am seeing great similarities between the businesses of oil field development and stock investing. Understanding these similarities - and the differences - may help us better understand the business of stock investing by analyzing it from another perspective and, hopefully, improve our investing performance.

Obviously the similarities of the two businesses start with the fact that both are risky businesses. In the oil industry, which is capital intensive and with high risk, the geologists and engineers (including the reservoir, production and financial engineers) try to evaluate and optimize the value of a portfolio of oil and gas fields by making predictions that are based on scant and indirect information as well as on assumptions that are thought reasonable, say, about the future oil price or the geologic models of the fields. As smart as we are - many of us have a Ph.D. degree - we still have to be aware that these predictions could be very wrong because the data or assumptions we use may be wrong, or simply because some future events are just unpredictable. How to manage the uncertainty and risk thus becomes the most important aspect of any oil field development project, even more so than making the predictions themselves.

In fact I would say the same principle should apply to any risky business, stock investing included, if the optimal outcome is to be expected. [Another example that comes to my mind is the business of medical care/diagnosis of patients.]. In reality however, many individual investors have no knowledge or a mindset of treating stock trading as an investing process that requires researches, i.e., making unbiased predictions that are based on data, assumptions and experiences, and requires managing, i.e., what to do when things do not work out. Trading on hot tips or emotion ("it's so cheap, let's buy more!") will most likely lead to disaster over time, as I painfully lived through several years ago.

The other similarities between the two risky businesses are:

1. Both are about making predictions and assessing uncertainty/risks by integrating all available information. Some information is better ("harder") than the other. More information does not necessarily mean better predictions or lower uncertainty/risk.
2. From the viewpoint of a statistician, many variables in the stock market and in an oil project are all random variables that behave as stochastic processes over time or space. Any individual's prediction of these variables, e.g., the fair value of a stock or an oil field, no matter how smart and experienced the individual is, is just one of many possible estimates in the market place or the workplace. The implication is that you should not bet (all your money) on any one particular outcome. Specifically we should not set or act on a fixed price target.

   [I always get a kick out of analysts who state/raise/lower a price target for a company with the precision after two decimal points, without specifying a time frame].

   [Based on the same analogy, I would go a step further and say: do not trade options, because it involves evaluating the probability of two events happening simultaneously: (a) a fixed price floor/ceiling (strike price), and (b) on a pre-set date - much harder to do than predicting a stock's movement direction (up or down) only.]

3. It seems true that people always under-estimate, thus are unprepared for, the magnitude of volatility in the market or the complexity of geology in an oil field.
4. The methodologies for analyzing stocks and oil fields are remarkably similar: most people use a combination of fundamental (valuation or physics-based) and technical(statistics-based) methods. [Here is another view on fundamental and technical analysis, in Chinese].
5. Trends: the golden rule of trend-following applies in both stock trading and reservoir modeling ( e.g., in reservoir mapping:

   "Do not go against a trend while it lasts, unless you have information that suggests otherwise, i.e., its reversal".

   In statistics, this is called "unbiasedness". Yet many people lose money simply because they are biased. They stubbornly believe that they are right and the market is wrong.

6. Discontinuities: an oil formation may encounter faults or other boundaries, causing abrupt changes in reservoir and/or fluid properties. Similarly a stock can gap up or down, sometimes significantly. Discontinuities cannot be predicted precisely, but there are things that can be done to anticipate or manage them.
7. Each stock or potential candidate for purchasing can be regarded as an equivalent of a unique project in one's entire investment portfolio. Just like in the oil business, a project calls for thorough researches beforehand and, once commissioned, requires frequent monitoring and management.
8. All theories of probability and risk management apply to both businesses. Nobody can guarantee 100% success rate, but the goal should be to win consistently in a probabilistic sense.

My experience is that, if you find a winning strategy, technically it is much easier to profit in the stock market than to profit from an oil project. In other words, it carries less risk. The reasons are:

1. Even though there are countless factors that affect stock prices in any given moment, it is still a 1D game - you just need to predict what will happen in another future time. By no means an easy task, it is possible in a probabilistic sense (for a small investor anyway). For the oil field, we need to build models in 4D, i.e., what happens in adjacent wells, blocks or layers and how things will change over time in each of these units. We also need to deploy sophisticated physical models in addition to empirical/statistics-based techniques.
2. The stock market is very liquid - in most situations you can cash out and go away. You can not, however, abandon an oil rig without taking huge loss and dealing with lots of related business and legal troubles.Your decisions are vindicated soon - in days or months, unlike in the oil industry it takes years or decades, if ever at all, to show the impact of the work that you are so proud of.
3. Stock investing can be done by one person. In fact, many very successful investors are loners who otherwise would not prosper in a corporate world such as a integrated oil company.
4. It's your own money and you are motivated. You don't need to beg other people for a budget in order to, say, drill a well. Of course you don't get free donuts either, and all loses are yours!

To be continued.

Shanda ????, the largest online game provider in China, dropped almost 20% today following its quarterly report which showed its first (big) loss in its young history. I've followed SNDA even before it went public - back in early 2003, when I seemed to be the only person not playing Shanda's online games everytime I visited the crowded "net cafes" in Shenzhen.
SNDA went to a high of 45 after it went public. I tried to short SNDA when it was down to 20s, but couldn't do it because no shares were available for me to borrow. Anyway I think I made the right call and it can be used as a classical case study for not buying such a 'hot' company, even though it had the number one market position. The rationales for my trying to go short at the time were the following:
First the fundamentals:

• Although Shanda had its spectacular growth in recent years, almost all of its revenue was from a few game s such as ChuanQi and PaoPaoTang.
• Shanda's games were developed by South Korean companies, which means that SNDA really doesn't have its own IP rights.
• Its business model, technologies and products can be imitated by others, i.e., with no barriers to new entrants.
• Kids tend to get tired of old games and instead want to play games from competitors: Netease and 9City.
• Government-imposed rules limiting playing time by youngsters.
• On my visit to Hunan Province in October '05, the “net cafes" there were almost deserted, a shocking contrast to a year ago.
• Teenagers in Shenzhen told me that the hottest online game then was another game called ReXueJiangHu?which was NOT Shanda’s game!

And technically the chart clearly showed that the best time was over for Shada:

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Note that, below SNTA's chart, I've also shown the one of UtStarcom (UTSI) albeit it's for the years of 2003-04. UTSI is another company that I've followed for many years (and did make a profit from it). See the striking similarities between the two charts? The similarities are not incidental: Both companies were growing rapidly by taking advantage of the explosive market demand for its products/services. However both had essentially one product and no technologies. Both are at the mercy of the Chinese government policies. When the market cooled down, competition heated up, they started to suffer greatly, and very rapidly indeed.
The prices for the companies today? UTSI at 6.4 and SNDA at 13.8! Both had a high of 45 not too long ago.
One more piece of information: during SNDA's stock price decline in the past year, the stocks of its competitors have been doing much better. Another warning sign!
The company have tried to to diversify revenue sources, but it takes time to implement the strategies and chances are that they will fail to meet the expectations. Shanda also made investment in other companies such as Sina and a South Korean game developer, but have actually lost money on these investments which explains the bulk of the huge loss in the past quarter.
Lessons here? Be careful with companies with one hot-selling product or service but no competitive advantages in technology or business model. Secondly, charts do work, at least in this case it did. Very often charts are the only hard data an individual investor will have access to.
The flip side of this is: if timed right, these companies offer great opportunities for shorting.