Let’s be real here. Investing is very much like gambling. You’re buying a piece of paper and betting it will increase in value and return a higher payoff. Ultimately to invest, you have to find some entity who is willing to take your bet and that would be the stock market casino. For investors looking to buy and sell stocks, there is technically one casino which is the stock market or the stock exchange. To access the stock market, the average investor uses an intermediary like a brokerage house to place their “bets” and pay them a modest commission to execute their bet. In addition, brokerages and stock market casinos also can act like a bookie and take other “bets” and create a market of specific bets by creating products that establish probabilities and paying out accordingly. Like casinos, there are many different types of games or investments you can play as an investor. Some have greater odds of success than others. Some casinos have certain rules or cultures that they operate under and they all cater to specific types of clients.
It is important as an investor that before you plunk down your hard earn savings that you understand how the stock market casino works and what kind of games you want to play, because they are very different and can potentially wreak havoc on your portfolio. Unfortunately most retail investors end up making bad investment decisions because they are playing the wrong games, where the odds are stacked against them and they don’t know any better. Our stock exchanges and financial institutions haven’t done a great job educating them of the risks and returns of playing in their casino. It really is important that you choose your games wisely when playing the stock market casino.
A typical stock market casino possess many of the same characteristics as a Vegas style gaming casino:
- Stocks are the equivalent of poker chips.
- They have tiers of “insider” membership and will “comp” their best clients (often high net worth or the ones that invest frequently) with more favourable perks, and price selection than the average retail investor.
- Lots of marketing glitz. The main message is that investing is overly complex and the only people that can understand it are “professionals” so trust us with your money and we’ll make you richer than…I won’t finish it. The stock market casino and the brokerage houses are always developing new financial products to entice investors to visit their casino. They will entice you to play in their casino with quick hits of information (e.g. earnings announcements) that will trigger reactionary buying and selling.
- The stock market casino, with regulatory blessings, can set their own rules and set it up so the House wins more often than the investor. There are some games where the average investor has a better chance of winning and some where you might as well hand over your money. For the average investor to beat the House requires daily monitoring, and an ability to mine for nuggets of information. The Internet has levelled out the flow of information that was once concentrated in the institutions, but even so, not many people have time to wade through all the mountains of information and miss-information that is online.
- The stock market casino and brokerage houses, love visitors that don’t know anything about investing (i.e. financially illiterate) and who are emotional, neurotic, impatient that view investing as impulse buy or a form of entertainment. I believe the phrase, “taking candy from a baby” would be a fitting under this circumstance.
Based on this, it appear there is little point in putting money in the stock market casino, however if you play the right games where odds are set by the capitalist indicators of the overall market and not games where the odds are made by the stock exchange and the brokerages, you can do quite well and even outperform the professionals.
There are 2 groups of games you can play as an investor. Each casino has different games, rules, and cultures
The “Machine Games Investments”
(Derivatives, Commodities trading, Currency trading, High Frequency Trading)
These investments are the equivalent to the casino slot machines and your video poker terminals. They can eat away at your savings, one spin at a time. Brokerages love these games because they are high margin and also because they can set the rules to ensure not too many people win. People play these games are hoping for the big monster payout where the lights are flashing and the alarms go off. These types of investments have the following characteristics.
- The games are quick: Short term investment horizons (Daily/Quarterly).
- The rules can be very complex and confusing, some requiring algorithms and exotic formulas to assess whether the investment is over/under valued.
- Force you to play lots of games resulting in the churning of your portfolio, which incurs more trading fees.
- Limited choices and choices that could have conflicts of interests.
- While the costs might be low to play per game (i.e trade), over time they can become prohibitive especially if you make a lot of trades.
- Small payouts. When you make these types of investments, you are playing for a 1% gain with the goal of turning over your portfolio and finding enough marginally mispriced assets to trade to make enough cumulative, successful 1% gains to make a decent return.
- You can go on some short term winning streaks with these games, but it is very difficult to win and grow your savings consistently over long term
- Risk: High (exposed to volatile types of games/investment products)
- Return Level for Individual Investor (net fees). Even if you were able to make enough 1% trades, the commissions would eat a good chunk of the return. So even if the stock market casino was losing the bets or trades, it was still guaranteed to make some money on the trade.
The “Table Games”Investments
(Common stocks, basic ETF’s, actual businesses)
These investments are the equivalent to the casino table games like poker and blackjack tables (Video terminals not included). These games take longer to play and if you can play well and make smart decisions and understand the psychology of the players around the table then you can exploit them for your gain. Brokerages don’t like these games because they can’t charge high commissions and also they cannot control the nature of the cards on the table. Economics and market psychology control the outcomes of these type of investments because table games carry a higher level of human interaction. These type of investments have the following characteristics.
- The games are longer and have long term investment horizons (Months/Years).
- The longer you stay in the games (i.e. the longer you are invested), the better chance for payoffs.
- The chips you receive from the Casino represent ownership in actual companies and businesses which could potentially share in the wealth created of the companies that are well run and can generate high Returns on Capital.
- You don’t have to play a lot. A portfolio of several stocks/bonds can generate much higher returns than a portfolio of 100 stocks. Because of the lower portfolio churning, trading costs are lower.
- Greater choice of games (i.e. businesses) to invest because you’re not just limited to games a specific casino is pushing. You can play in a Canadian casino or a US casino.
- It costs less to play games: Because the games are less complex and require less overhead to manage, they carry lower commissions
- Larger payouts. When you are playing the Table Games and less of them, you are playing for double-digit gains. If you are good at Table Games and looking for significantly mispriced assets, you can generate much higher returns without churning your portfolio and pay higher commissions over a longer period of time.
- Very little marketing glitz. These games can also be quite boring because the types of investments are not very glamorous, although CNBC and other business media do a pretty good job of trying.
- Because you are playing games with longer timelines, you can go on very long winning streaks and grow your savings more consistently over the long term.
- Over the long-term, the odds favour the investor, because the broader economics and the market will set the price and direction of the stock. House will win but less often.
- Risk/Return: Medium. All games carry risk, some games/investments will have low risk, but low return, while some games will contain higher risk, but also a possibility of higher returns. Eventhough these type of games still carry a high level of risk, the average investor has a better chance of winning by playing and investing in the Table Games rather than by the Machine Games.
As you can see, it is very important for an investor to understand what games they are playing in the stock market casino, because some games skew in favour of the stock market casino, while some games are driven by the broader market which allow the ordinary investor a better opportunity to make better, profitable investments. The investor must also try not to get sucked in by marketing power of the casino as they will be trying to guide investors to games that they can charge you more to play and where the rules are setup so that the probability of winning is higher in their favour. It is important for investors to become more street smart in understanding the dynamics of the stock market casino and the psychology of participants so they can exploit their behaviour for gain.