In my regular surfing of the Internet, I found a story written by George Hartman, author of Risk is Still a Four Letter Word. I thought it was definitely worth sharing:
The story is about a man named Dave. Three months ago, he received an unsolicited investment newsletter that promised to predict stock market movements. As proof, the letter went on to simply state, “The market will go up next Friday.”
Dave didn’t do anything at the time, except listen for the market results on Friday, out of curiosity. Sure enough, the market went up.
One week later, he received a second letter from the same forecaster. This one said, “The market will go down next Friday.” Again, Dave did nothing and guess what? The market fell on Friday.
By early the next week, Dave was anxiously awaiting the letter. When it arrived, the message was, “The market will go up on Friday.” This time, he decided to get a piece of the action so he instructed his broker to buy in. The market jumped on Friday and Dave made a quick $1000.
The fourth week’s letter called for a further rise but added, “To continue receiving this letter, please send $100.” Dave sent the $100 (after all, he’d already made $1000 profit), bought in again, the market climbed and he made $2000.
The following week’s newsletter warned of a decline, so Dave told his broker to short the market. The prediction again proved true and he pocketed $3000 minus the $500 the letter now demanded for its continued advice.
The sixth week’s forecast another rise, on which Dave bet more heavily. Once again the prediction was bang on and he pocketed more than $5000, even after responding to the request for $1000 to keep the letters coming.
And then, finally, it happened – a wrong prediction. Dave lost $10,000 plus the $1000 fee demanded once again.
And the next letter? Well, it never arrived and Dave hasn’t heard from the market-timing wizard since, although lots of other folks in different cities have. That’s the other side of this story.
Dave’s guru, you see, travels around a lot, settling every few months in a new large metropolitan area. He buys mailing lists from local upscale publications and selects a target market of about 50,000 people.
The first mailing is free of charge and half the people on the list (25,000) receive advice that the market will go up. The other half are told it will fall. Those who received a prediction that turns out to be correct receive a second letter. Those who are given the wrong prediction are not contacted again.
The procedure is repeated for the third letter except, of course, the list is now down to 12,500. By the time the fourth letter goes out, 6,250 people will have received three consecutive correct predictions.
The experience of this “market timer” is that about 40 percent (2,500) of this group will respond to the request for the initial $100. That puts $250,000 into his bank account.
The 2,500 names still on the list are, of course, cut in half again by the 50/50 probability of receiving a correct prediction. But experience has shown that about two-thirds (830) of those remaining will now gladly forward the requested $500 after getting their fourth correct prediction in a row. That nets the “expert” $415,000 more.
By the fifth week, only 415 recipients, including Dave, have made it through the screen of no incorrect predictions. So it isn’t hard to believe that at least 75 percent of them would gladly shell out the requested $1000 renewal fee. That brings $300,000+ through the mail to the market timer.
The process is repeated until the list of “qualifiers” is too small to be profitable which normally occurs somewhere around the $1,000,000 mark.
The good news is that the foregoing tale, of course, is not true. In fact, it is based on an old Alfred Hitchcock storyline and similar scenarios have been developed in several investment strategy books over the years.
For me, this story reminds me of the old saying, “If it’s too good to be true, it probably is.” Be careful and remember my theory of perfection – it does not exist in investing.
NOTE: The story above is taken from the http://www.advisor.ca/ website.