Many years ago, there was this Hollywood movie named ‘Conspiracy Theory’. The main character of the movie believed in all sorts of conspiracies. Since this was before the age of WhatsApp and Twitter, he would print a newsletter with these theories and sell it on the streets. One of his theories was that the US space shuttle Atlantis was testing an earthquake weapon. He had authentic newspaper clippings to prove that during every single one of Atlantis’ missions, there had been a significant earthquake somewhere in the world. The interesting thing was that this was actually true and in real life too, not just in the movie!
The problem was that he never looked for earthquake-related news items during the times when Atlantis was NOT in orbit. As it happens, there is at least a magnitude 5 or 6 earthquake somewhere in the world practically every day. If you followed the above technique, you could actually ‘prove’ that there is an earthquake somewhere in the world every time a major new COVID variant is discovered or every time the dollar falls in value.
Unfortunately, far too many equity investors feel that there are some hidden mechanisms behind stock prices too. How does the stock market work? I don’t mean that question the obvious way – that it’s a place where people buy and sell stocks through brokers. What I mean is how you think stock prices are really set. What is your mental model of how prices are decided?
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