Understanding the Game
In high school I took a class introducing the basics of investing. Our teacher, a nice man who vaguely resembled Auric Goldfinger from the James Bond movie, had the somewhat unenviable task of teaching investing to a bunch of adolescents with no formal accounting or finance training. I remember going through the Investor’s Business Daily (IBD), looking at the daily stock quotes and a list of companies picked by IBD as most attractive based on a combination of earnings, stock price performance, and other factors like relative strength. I also recall spending a fair amount of time going through the Dick Davis Digest, an investment newsletter offering short summaries of companies with recommendations of individual stocks
One of the great attractions of this class was entry in a stock picking competition that pitted small teams of students across the state of Michigan against each other. For the competition, which ran for approximately two months, I paired up with a friend. As two highly competitive individuals who viewed ourselves as future investment professionals, to say we wanted to win this competition would be an understatement. I’m not sure exactly what we thought passed for thorough analysis at that point, but we certainly did it, ultimately settling on some blue-chip names and if I remember correctly, a company speculated as a takeover target.
Fast forward two weeks and we were in something like 40th place out of around 100 teams. Not great. Our portfolio of stocks had done fine but we quickly understood that we had employed the wrong strategy. Change of plans…forget picking solid stocks/companies that should do well over the longer run. We need more action! Understanding volatility is persistent—it begets more volatility—we went to the IBD to look up the biggest movers from the prior day. Up or down 25% yesterday? Great! 50%? Even better!! Our charge up the leaderboard was led by an investment in Saatchi & Saatchi, which rebounded sharply after previously headlining the “biggest losers” list. Other than knowing the company was involved in advertising we knew nothing about it. Did it really matter? We just needed stocks that moved a lot, and it fit the bill. We casually flipped stocks from then on out, sometimes riding the momentum of a fast riser, other times banking on a rebound for a recent loser, rarely doing any research. We finished first in our class and just outside of the top 10 in the state. Not bad, but the contest wasn’t exactly packed with lessons you’d want to teach a young investor.
Stock contests pop up every now and then (my father recently informed me he’s participating in one with a senior men’s group) and based on experience here is my general advice if you choose to participate. First, diversification is a losing strategy. Don’t be a wimp, go all in on a single name. Second, the stock you choose should be something extremely volatile…you are playing to win, not trying not to lose. Like Ricky Bobby says in the cinematic masterpiece Talladega Nights, “If you ain’t first, you’re last.” Small, generally illiquid stocks help as they can move sharply. Also, it can help to select a stock with high short interest that could result in a short squeeze on any positive news, rocketing shares higher.
Generally, avoid the types of companies you’d label a sensible investment for a long-term account, you might end up in a respectable spot on the leaderboard, but your chance of winning is low. These contests are fun, but I view them as closer to Super Bowl pools than to something testing any sensible investment strategy.
The trend towards gamification in markets has seemingly become stronger in recent years, with ever more opportunities to participate in highly volatile instruments or securities. The popularity of meme coins and short-dated options, which offer investors the chance to bet on whether a particular stock or index will rise or fall in the near term, serve as some evidence. Levered, single-stock exchange traded funds also have become more popular. These products magnify the results of what are often already-volatile stocks like MicroStrategy, Tesla, and Coinbase. Bloomberg recently reported a record amount of funds have flowed into single-stock ETFs this year. One popular levered ETF, the GraniteShares 2x Long NVDA ETF, offers investors the 2x daily percentage change of Nvidia stock. Assets in that ETF reached a peak of $6.7 billion in 2024. For those seeking action, there are seemingly a growing number of investment alternatives to satisfy that desire. As the market adage goes, “If the ducks are quacking, feed them.”
To be clear, there are many different approaches that can lead to success in the market including short-term strategies involving volatile securities. We don’t claim to follow the only strategy for making money in the market, but the philosophy we follow happens to make sense to us. History suggests it is a sensible path for long-term investors to follow. If you can trade zero-day options successfully, or profitably utilize some other short-term strategy, more power to you. However, others are simply gambling when utilizing some of the investments that have become more popular of late.
The Wall Street Journal recently included an interesting article on how Gamblers Anonymous meetings are filling up with stock market participants. Apparently there has been a spike since the pandemic given the increasing popularity of alternatives to score large, short-term gains. Options activity is set to break yet another record this year, and trading in options set to expire the same day now accounts for more than half of all option trades on the S&P 500. The article also suggests that gambling in financial markets often goes undetected because the gamblers categorize their actions as investing. It sounds more respectable, maybe even somewhat sophisticated, to say you employ a strategy of buying short-dated options on the S&P 500 versus taking the Rams -7 at the Raiders.
Warren Buffett’s teacher Benjamin Graham offered many pearls of wisdom, but one of his most well-known is, “Investment is most intelligent when it is most businesslike.” At its most basic, his belief was to approach a potential investment with the same careful analysis and mindset as if you were to own that business entirely, focusing on long-term value. Many of the products offered in the current market veer far away from this notion, with a focus primarily on near-term potential.
Even among investors with short-term horizons there is a key difference. I remember reading one of the books in Jack Schwager’s excellent Market Wizards series that includes interviews with successful traders. One item of many that stuck with me was when Schwager asked a trader if he ever felt a sense of excitement as he put on a position. Given his use of a highly disciplined approach, the trader was almost repulsed by this idea, saying if he felt any emotion at all putting on a trade, he had likely made a significant mistake. I suspect this sentiment is rare amongst many with short-term holding periods. The trend toward increased gamification of markets suggests we continue to drift further from the important lesson offered by Graham while most would be better served over the long run by heeding his message.
James M. Skubik, CFA®