Is the Stock Market Just a Big Casino?

I hear it all the time, “the stock market is just another way to gamble.” But is it a gamble or a calculated risk?

Let’s back up a minute and talk about balloons. Yep, ballons!

What happens when you keep pumping air into a balloon, over and over and over and over again? It eventually pops, right?

So what do you think happens when you keep pumping money into a company (or index) over and over and over and over again? Eventually, it too pops.

Some companies become so overpriced, for whatever reason (usually has to do with profits), that investors begin to sell their stake in them – the stock pops!

If a company is selling for $50 per share (hypothetical) but it is only worth $20 per share on paper, eventually a sell-off will ensue. The company at $50 just cannot keep up with its profits.

Or maybe they were committing accounting fraud, who knows!? But either way, they’re just too expensive for whatever the reason.

Now, take that same company and multiply it by thousands. Why? Because there are thousands of companies in the stock market. Sure, some might be undervalued (worth $50 but selling for $20). But some are also overvalued (worth $20 but selling for $50). When the balance tips in favor of overvalued companies, you get a bubble. Or balloon, you choose the wording.

When there are more overvalued companies than there are undervalued companies, things get risky when buying. This is when a lot of investors will sit on the sidelines in cash… or, they might buy bonds instead. They see the bubble (or balloon) expanding, and they know it will eventually pop (sell-off).

So what in the hell is my point?

Retail investors (you and me) are always the ones to get caught with our hands in the cookie jar at the top of markets. What happens is this: Joe Blow, your market wizard neighbor, sees that company ABC (hypothetical) has been moving up for a month or more. So what does he do? He says “WOW! This is fantastic. Easy money!”, and he buys shares of company ABC.

This is fine if Joe Blow bought the shares at a decent price. But if he did not buy at a decent price, then Mr. Market and Smart Money might decide to sell their shares soon because the company is now overvalued. And when Mr. Market and Smart Money sell shares, it’s usually in extremely large blocks – millions, if not billions of dollars worth. This, of course, drives the share price of company ABC down. Joe Blow is now bankrupt because he invested his whole life savings into company ABC.

Getting back to the original question, “Is the Stock Market Just a Big Casino?” The answer is a resounding NO, in my opinion.

The problem with most (the average) retail investors is this… they fail to do their homework. They don’t perform technical and/or fundamental analysis on the companies they buy into. They, in essence, have no idea what’s going on. So instead of chocking it up to a learning experience, they simply say dumb things like “the market is a big casino. It’s all just a gamble.”

I firmly believe investing is a calculated risk, and not a gamble. This is just my opinion. I relate it to buying a house; would you go out and buy house without researching home values in the area? If you don’t, you might pay thousands more for the house than you needed to. This basic concept applies to the stock market as well.

With all that said… you are never going to win them all. I don’t know of anyone who ever has. Even Warren Buffett has lost on investments.

But with solid analysis (technical, fundamental, or both), I believe it is a calculated risk and not a slot machine.

How Accurate Can They Be?

I have always been split 50/50 on the Market Efficiency Theory. What this theory suggests, is that all information is already baked into the share price. This is the premise behind technical analysis.

If a stock is trading at $100 per share, market efficiency tells us that the share price is absolute (more or less) and has already factored in all available information. The theory suggests that the share price is reflecting company financials, company direction, company head-winds, and any other company info that might be important to know. No work is needed on your part, says the market efficiency guru.

So, I did a little study to see how accurate consensus estimates are. After all, if market efficiency is true, then you would think estimates would be somewhat accurate. Wouldn’t you? If a share price is absolute, and “is what it is,” then the market makers who set these prices have to base them off of something. Company financials are certainly a big part of the theory.

First, here were the rules for my study:

  1. I couldn’t pick the companies. I asked my Facebook group to pick random companies. Those companies had to be legit, and could not be garbage OTC companies. However, I did have to switch 4 companies on my own, as the previous 4 did not have enough financial data on the website I used. The companies I picked were ROKU, AMZN, AMD, and Macy’s. I used 10 random companies total.
  2. I used the same financial website for all data. I used Markets Insider. I also used the same 3 quarters of information for all companies.
  3. I used earnings per share (EPS) and revenue (Rev), as those two are the “big” ones that are looked at closely.
  4. I simply took the difference between estimate and actual, and then found the percentage in which it was off from the actual. From there, I subtracted the percentage it was off from 100%, and used that as my study’s accuracy level.

So what did I find out? Let’s see…

The first 5 companies: Disney, Tesla, Apple, Shopify and Amazon.

The second set of 5: Goldman Sachs, Kinder Morgan, Advanced Micro Devices, Macy’s and Roku.

The overall accuracy for EPS was 73.36%, and the overall accuracy for revenue was 95.87%. That’s pretty impressive if you ask me. The only companies that brought the overall accuracy down were the “wild card” companies: Tesla, Shopify, and Roku. I call them wild cards because they’re technology based. Except Tesla. Tesla is a wild card because it’s a new space in the auto sector, and their CEO is a little bit of a loose cannon.

You can take what you want from this little study of mine. But for me, it brings me a little bit closer to believing the efficiency theory. Am I all in on it? Nope. But I’m closer than I was before.

However, there is still the unforeseen to contend with… Elon Musk tweeting that he may de-list his company and go private, for instance. Or the sex scandal at CBS, or shady accounting practices at Enron. The list goes on. There is much in the market that makes things not efficient.

As I always say, there is absolutely no way to predict the market with 100% accuracy. There never has been, and there never will be. But, I’d take 73.36% or, even better, 95.87% accuracy ANY day of the week!

Does Number of Shares Matter?

I can’t tell you how many times I am told that “Amazon is too expensive!” Or, “I can’t buy that, it’s too expensive. It wouldn’t be worth it.”

Time and time again, it never fails. But is a stock being “too expensive” a reason not to buy it? Here is the argument (usually) for not buying the stock because it’s too expensive: Because you won’t be able to make enough money, because you can’t buy enough shares.

Ok… So I’d be a liar if I said I did not think the EXACT same thing when I first started out investing. I thought you had to buy a million shares of something to make a good return. Until one day my dad said “you know a percent of $1,000 is the same regardless if it’s one share, or two, or three, etc… right?”

I was dumb-founded by such a ridiculous comment. “Ughhhhh!” I thought, “how dare he question my judgement.” After all, I was a brand new investor/trader and new everything already, DUH! I knew without a doubt that the more shares you had of something, the better off you were. I was sure of it… until… I thought about it.

Let’s use $1,000 as a nice and easy number. Assume that stock ABC (hypothetical company) is selling for $1,000 per share. And stock DEF (hypothetical company) is selling for a measly $100. Obviously I can make more money with 10 shares of DEF, than I can with one share of ABC, right??… NOPE! And here is why:

(Not including fees) I buy 10 shares of DEF at $100 per share, for a total of $1,000. You buy 1 share of ABC at $1,000 per share, for the same total – $1,000. A month later, both company’s stocks are up 15%. WOW! We nailed this trade. GREAT JOB! So who made more money? We both made the exact same amount… I know, right! Shocking!

Your 15% gain on 1 share of ABC is $150. My 15% gain on my 10 shares of DEF is also $150. Wow, who would have guessed!? See my point? It makes no difference what the share price is. The ONLY thing that matters… let me repeat that… the ONLY thing that matters is how much money you are willing to spend and/or risk. That’s it!

I bring this up because of Amazon – a very high priced stock, but a very good company (in my opinion). Amazon right now is selling for roughly $1783 per share. Would my money be better spent on 10 shares of something that costs $178 per share? Or even 20 shares of something that costs $89 per share? Or would my money be best spent by purchasing one share of Amazon? In the end the money spent is the same, the number of shares makes no difference at all.

Don’t let the price tag turn you away. Good solid company’s sell for whatever that good solid company sells for. Maybe there are GREAT stocks for under $100 (and there are, trust me). But maybe that $1,700 stock is also a really good buy. Always remember that the amount you have to spend and/or risk is all that matters. The number of shares you own should mean nothing to you.

The Holy Grail of Strategies

Have I got some news for you or what!? Are you ready… are you sure? Here it is….

The Holy Grail may exist! Woo hoo! But, unfortunately, the Holy Grail of trading strategies, most certainly does NOT exist! I know, bummer, right?

Some claim to have the “perfect” strategy, or the “best” strategy, or the strategy that will make you a multi-gazillionaire over night. I got news for you – they’re lying!

There is no such thing as a perfect trading plan or strategy. If that existed, we would all win our trades 100% of the time, and we would all be wealthy beyond our wildest dreams.

But, the good news is that there are strategies that increase your odds. There are also ways to mitigate risks before you even choose the strategy you want to implement, and that is by utilizing solid analysis skills (doing your homework).

I never enter a position based solely on a “gut feeling.” I never enter a position based solely on “well, it’s gone down this far, it has to turn around.” Yes, I will admit, however, that I do sometimes think those things, but only AFTER I have done my other homework first.

I utilize both technical and fundamental analysis. Some people just use one or the other, and that is 100% OK. I just personally think that they work best when used together. One compliments the other, so to speak. In specific, I believe that technicals compliment fundamentals. What I mean by that is – technicals move based on the underlyings fundamentals. That’s just my opinion. It works for me.

Back to the “Holy Grail” of trading strategies… They don’t exist! You will NEVER find it! So stop looking. Instead, find a strategy that works for you. Make sure that strategy has logic and reason behind it, and make sure that strategy involves some kind of risk management. Over time, if your strategy is solid and it works, you should make money. Will you become a millionaire with it? I don’t know! It’s possible, of course. Anything is possible with hard work and dedication.

Ignore the people that say their strategy is better than yours, or they know more than you do. Blah blah blah! These people, in my opinion, have nothing of value to share with you. They just want to brag and sound cool, but probably are not as smart as they think they are. I’d rather follow the people who are humble and do not push their strategies on me. The people I like to follow have tons of information to share, and never brag about it.

For example: I “ran into” a gentleman in a Facebook group named Nicholas. He runs ‘Option Alchemist.’ He’s a very smart and humble options trader with many many years of experience navigating the markets. I have been talking to Nicholas for only a couple of weeks, but I have already learned quite a bit via “small talk.” These are the types I’m looking to learn from, not the bragger.

If you are interested, you can find Option Alchemist on Facebook, Twitter, and their website. Here are the links: Facebook, Twitter, and website.

Ok, my rant/lecture is done. I hope you gained some insight if you are a new trader. The market is full of gimmicks and “get rich quick” schemes. Ignore them. They don’t have the answer you’re looking for. They don’t have the Holy Grail!

PERCENT GAIN? OR DOLLAR AMOUNT?

What’s more important: Percent gain or loss, or dollar amount? If you ask me… 100%… percent!

First, let’s discuss why, no matter what your account value is, the percent gains or losses are the same.

If I have an account with $100,000 and you have an account with $1,000, what I make (or lose) will be much more than what you make (or lose), but the percent gain (or loss) will be the EXACT same.

So… Stock ABC (hypothetical company) is trading for $10 per share. We both want to buy shares because ABC is an awesome company and we think it’s going up from here. Our risk tolerance is 2% of our account value. That means my risk is $2,000 (2% of $100,000) and your risk is $20 (2% of $1,000).

For the sake of this example, I will leave any trade fees out of it.

With your $20, you purchase 2 shares ($10/share). With my $2,000, I purchase 200 shares. And wouldn’t you know it! The very next day ABC jumps up $2 per share. WOO HOO! Our analysis was correct, and we decide to exit the position with a profit.

You bought 2 shares, so you made $4 ($2 gain per share multiplied by number of shares). I bought 200 shares, so I made $400 on the trade. Fantastic! I made much more than you did… neeeener neeeener, pumpkin eater!! But guess what? Our percentage of profit was identical.

We each gained 20% on the trade, and .4% on total account value. Here are the numbers:

My account – $400 gain on a $2,000 position is 20%. $400 gain in a $100,000 account is .04%.

Your account – $4 gain on a $20 position is 20%. $4 gain in a $1,000 account is .04%.

Well well well! Would ya look at that. We both made a GREAT decision to buy. I’ll take a 20% gain for every trade I make EVERY DAY OF THE WEEK!!

What is my point with all this? That’s easy… ignore the bragger types and the ones who say stuff like “well, try doing that with a large account,” or “ya, but your account is so small.” Blah blah blah!! In investing/trading, what matters the most is that you make good investments/trades. The only way to know if your investment or trade was a good idea, is the end result. And the end result ends in a gain or loss, period! The fact someone is a millionaire, and I’m not, means nothing! Just because they’re a millionaire, does not mean they’re a good investor or trader.