So how do you make money in the “markets?”

Since luck is pretty hard to control, let’s talk about the second factor:  having non-public information.  Now, of course there are two types of non-public information.  The legal type and the illegal type.  Here at IBankingFAQ, we recommend the legal type, at least in the United States (we give no such recommendation for those investing outside the U.S. )  Most of you probably know what the illegal type is – usually called “insider information.”  An example of this would be investing in an airline of which your Dad has influence over union decisions.

The legal type would be any information not known by the broader investing community that has not been obtained illegally (i.e. in violation of SEC or other regulatory body regulations).  For example, hedge funds that cover retailers might send consultants to a retail store to count cars in the parking lot or peak into stock rooms to count inventory levels, given them non-public insight into the financial results of the retailer.   Or perhaps a doctor, due to his or her own specialty has indirect insight into the likely success or failure of a new drug in clinical trials.  Or maybe a mutual fund manager has the ability to meet directly with a management team.  Even if no non-public information is disclosed by the CEO during that meeting, the fund manager might have insight into the quality of the CEO that other market participants, who do not have the ability to meet management, cannot have.  Keep in mind that often there is a very fine line between legally obtained non-public information and illegal insider information.

So how does one go about legally obtaining non-public information?  Well, aside from the examples I’ve given above, the answer is that it is usually extraordinarily difficult as an individual investor and still extremely difficult as an institutional investor.   The short answer is if you’re going to try to make money in financial markets,  concentrate on less efficient markets such as small cap stocks or emerging markets but ONLY if you have the ability to uncover non-public information.

The even shorter answer is, its nearly impossible for an individual investor (or institutional investor such as a hedge fund) to outperform the market so don’t even try.