I just finished reading A Mathematician Plays the Stock Market by John Allen Paulos, professor of mathematics at Temple University. Being a scientist with a theoretical bend, I was readily drawn towards the title of the book.

I expected some sprinkling of mathematical expressions here and there, but to my surprise, there is none! In Paulos’ own words, he wanted to use “vignettes and stories rather than formulas and equations” to “explore the basic conceptual mathematics of the market”.

I enjoyed his engaging style of writing, and the “cloyingly personal account of how I lost my shirt” with WorldCom stocks was a first. (I mean, most investing books come across as an impersonal collection of dos and don’ts, as though the author is too smart to do such dumb thing as buying telecom stocks in the middle of dotcom bust.)

Most of the material presented here is already covered in many other (more famous) books, so there is little here for a knowledgeable investor, at least on the practical side of investing. (For those of you looking for hands-on advice, I would suggest Burton Malkiel’s classic A Random Walk down Wall Street. If you are a total novice, Andrew Tobias’ The Only Investment Guide You’ll Ever Need is a great first read.) This book does not offer any financial advice, such as how to construct a high-yield portfolio or pick the hottest stocks (what Paulos calls “financial pornography”; the term, though, is originally attributed to Jane Byrant Quinn who wrote investment pornography).

Like most academicians talking about investing, the bias is strongly in favor of efficient market hypothesis, rather than fundamental analysis (the first one gave us Nobel Laureates, the second one gave us Warren Buffett). But Paulos, like Malkiel in later editions of his book, acknowledges the merit of the latter, at least over short time scales. (If the market is really that efficient, how does one explain bubbles and bursts?)

The problem is though, after adding up the time and effort spent researching the fundamental attributes of a company, and the transaction costs (and other fees), you do not gain much over the set-it-and-forget-it armchair investors who rely on market efficiency and put their faith in index funds.

The book gets really interesting in the last two chapters, where Paulos discusses such technicalities as complexity, chaos, power laws, fractality and paradox, all using simple language. I particularly liked his arguments proving “if efficient market hypothesis is true, most investors will not believe it, and if it is false, most will believe it”.

This does make sense: if most investors believe market efficiency to be true and do not react to new developments (an efficient market will already have incorporated them into prevailing stock prices), the few non-believers will exploit these developments and to them the market will respond slowly, thus falsifying the hypothesis. You can turn the argument around to prove the other half of the paradox too. Paulos thinks the efficient market hypothesis is “neither necessarily true nor necessarily false”.

To wrap up, I recommend this book as a general reading to savvy and novice investors alike - the former ones will enjoy the honesty of personal narratives (besides the easy intellectuality that permeates through the book), and there is enough stuff in here to teach smart investing to the latter ones.

See related posts:

1. My take on investing books