I’ve listened to the audio version of Ken Fischer’s wonderful book, The Only Three Questions That Count: Investing by Knowing What Others Don’t. He explains simply, insightfully, with a good deal of wit and a healthy dose of cynicism how to think about investing. He points out that most people learn investing as a blacksmith learns their craft — at the foot of a great master. Although there is little wrong with this, investing is only partly craft and the rest is cannot be learnt but must be discovered. (What he seems to omit is that the process of discovery is another sort of craft). It is this process of discovery that he teaches in the book. Fischer calls the results of the discovery Capital Markets Technologies. You can think of them as tools, inventions or as technology, but Fischer warns against the dangers of considering them immutable laws. Markets change and so do the tools that work.
The only way to make money in the markets, according to modern financial theory, is to know something that others don’t. In trading, this is typically called an ‘edge’. Initially this smacks of insider trading, but this does not have to relate to knowledge about a company, but could more plausibly be discovering a technology that few else understand. The best secrets are those that are hidden in plain view. Many investors acquire beliefs about trading by reading financial media, talking to other investors or at the foot of the master of their craft. Some of these beliefs are indeed powerful technologies but many are either false or false when taken out of context. The first step is to get a good handle on the root assumptions that lie beneath many beliefs.
In The Only Three Questions That Count Mr Fischer looks at three ways to get an edge on your fellow investor: find things that are false that others think are true, work out things that others can’t or work out ways to work with the market more rationally. These three imperatives are three questions of the title.
The essence of many of the ‘things’ are correlations between commonly occuring financial instruments: do high oil prices mean low stock prices? Does the VIX, the investor’s volatility thermometer drive prices down? Is a weak dollar bad for US stocks? Is a strong dollar bad for European stocks? Mr Fischer shows how to do the investigative work yourself using freely available data. What is fascinating about this is that even when you discover that a new rule (e.g. oil is not actually correlated with stock returns), people keep on believing the opposite (e.g. high oil prices mean low stock prices) giving you an edge that will keep on paying out, until the majority understand what you understand and the market prices it in before you.