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.

Ominous Signs in this Market Indicator

The stock market has been on a rip lately. The S&P has risen well above 3000, and currently sits at 3120.5 (^GSPC Chart). But how high will we go without a pullback? More importantly, how big will that pull back be?

Yesterday, while trying to find clues, I put the ‘On Balance Volume’ indicator on my SPY chart. This indicator basically gives you an idea of accumulation and distribution in the market; it tells you, in general, if the market is scooping up shares, or selling shares. I use the OBV from time to time, but have not used it in a while. What I found was scary.

SPY chart as of 11/15/2019

Notice the descending trend on the OBV indicator? More importantly, notice the pullbacks that have happened each time the OBV dropped in relation to the market rip higher?

At the end of last year we had a correction. The markets tanked for a couple months, and finally bottomed out on December 31. Since then the market has climbed to all-time highs setting record after record.

Our first substantial pull back of this year happened right after the May high. This is when the Trump administration basically said a deal with China was currently off the table. The markets did not like the news one bit, and down it went. From there it rallied to new all-time highs in July.

Same story in July – more negative trade news, and the market soon fell. However, the fed started to talk about lowering interest rates, and the market liked that. It soon rallied again in September and met up with the July all-time high. Then, of course, another pullback on… you guessed it… negative trade news. Since the pull back bottom in early October, we have rallied to even higher highs. The market is on a rampage!

But there are ominous technical signs that this is not sustainable without some sort of pull back or correction. Take a look at the chart one more time:

SPY chart as of 11/15/2019

The blue vertical lines are meant to show the market highs in relation to the OBV. The red arrows, of course, are pointing to the highs of the OBV in relation to the blue lines. The blue dashed line on the indicator shows the May OBV high, and the purple dashed line shows the July OBV high.

Notice, each all-time market high comes with a lower OBV high. This is divergence. The On Balance Volume indicator is showing divergence with the overall market.

After the July market high, the market pulled back. The OBV might have predicted this, as it could not reach the May OBV high. Same story for the September rally – the OBV might have predicted that one as well. This time, the September OBV could not reach the July OBV high or the May OBV high. And here we are today. The OBV is right at the September OBV high, but well below the July and May OBV highs.

Quite a tongue twister that last paragraph was. LOL! But you get the idea.

There is one other ominous sign the OBV is giving me. Notice the OBV has been slow to rise during this current rally when compared to the other rallies? That is showing that there is lack of conviction in this move. It seems market players are leary about moving forward on the current trajectory. The other rallies showed steeper OBV rise.

As I always say, this does not guarantee a pull back or correction will happen any day now. There is no “holy grail” of market indicators. The OBV is no exception to that. This is just something I noticed and wanted to share.

This post is my opinion only, and should not be taken as advice. Always do your own research before making any investment decision. Seek professional and licensed advisers if you are unsure.

How Does Short Selling Work?

Short selling is a way to potentially make money in a bear market. When stocks go down, you can profit. Crazy concept huh? After all, as the saying goes, “buy low, sell high.” With short selling, the saying goes, “sell high, buy low.”

This is actually a strategy used by many, even in bull markets. There are always short selling opportunities. Do I short sell? Nope, never have. I do buy put options, which is kinda-sorta the same thing.

So what is short selling?

You borrow shares from your broker and sell them on the open market. Later on – if your analysis was correct and the share price drops – you buy the shares back at a cheaper price than you sold them for, and you keep the difference as profit.

Let’s say ABC is currently selling for $100 per share. You have done your research and proper analysis, and you think ABC is going down. So, you enter a “sell to open” order with your broker, for 100 shares. Your broker lends you those shares and they are automatically sold for $10,000 ($100 per share times 100 shares).

The $10,000 goes into your account, as that is what you sold them for. But DO NOT SPEND THIS MONEY, lol… the trade could go against you.

A week goes by and ABC is down $10 per share to $90. Woo hoo!! Fantastic analysis you did. You decide to close out your position by placing a “buy to close” order. The order is executed, and you just bought the shares back for $9,000 ($90 per share times 100 shares). The broker gets their 100 shares back, and you keep the difference of $1,000 ($10,000 you sold for minus the $9,000 you bought them back for).

Short selling was a bit confusing to me when I first learned of it. I thought, how in the world can you make money when a stock goes down. Well, if your broker is willing to lend you shares, that’s how. You do need a margin account to place short trades. And, of course, margin accounts can be very dangerous for a multitude of reasons.

If you are interested in short selling, contact your broker to find out what you need to do. Also, DO YOUR RESEARCH AND KNOW WHAT YOU ARE DOING FIRST!!

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!

To Short… What Does That Mean?

The concept of shorting really tripped me up when I first started investing. Before that, I always assumed the only way to make money investing, was to buy. You know – “buy low, sell high.”

But, what I soon learned was that “sell high, buy low” was also a very valid concept. In fact, once I figured this out, I knew that I was going to be able to make money regardless if the market was bullish or bearish. Of course, you still need to know what you’re doing… but in theory, money can be made in a bull or bear market; recession or crazy hot economy. Makes no difference.

But what is shorting? Short selling is the borrowing of shares from ones broker to sell in the open market, and buying those same shares back at a cheaper price and profiting on the difference. Let me explain:

Let’s assume I am bearish on company ABC (hypothetical company). I think they suck, and I think they will drop 5% in price within a week. Currently, ABC is selling for $100 per share. I want to short them, so I open a short position via my trading platform for 10 shares. When I “Sell to Open” via my broker, my broker then lends me the 10 shares I requested, and they are automatically sold on the open market for $1,000 (not including fees).

So, to recap: I borrowed 10 shares from my broker and sold them for $100 per share netting me $1,000 that is deposited into my trading account.

A week goes by and ABC stock did exactly what I thought they would – they tanked 5%. WOO HOO! What a great analyst I am! So ABC is now selling for $95 per share – $100 minus $5 (5% of $100) equals $95. I decide to close my position by placing a “Buy to Close” order.

Now I am buying back the shares that I borrowed, so I can return the borrowed shares to my broker. But, I am buying the shares back at a cheaper price than they were when they were loaned to me… so I get to keep the difference. I sold ABC for $1,000 (10 shares at $100 per share), and bought them back at $950 (10 shares at $95 per share) to give the 10 shares back to my broker. I get to keep the difference – $1,000 minus $950 equals $50. I just made $50, or 5% on my return. FANTASTIC!

The example I gave was for short selling stocks. However, there are other ways to short like buying put options. A put option… simply put (LOL LOL)… is an option contract that you purchase when you think the underlying is going to fall in price. But put options are for another article. Just know that with a put option you are not borrowing anything, rather, you are buying with your money a security that will allow you to profit when the underlying falls in price.

Understanding short selling broadened my horizon in terms of investing. With a good understanding of short selling, it is entirely possible to profit in a bear market, the exact same as you can in a bull market. But, like any other investment type, short selling carries certain risks that other strategies do not. As always, it is absolutely necessary for you to educate yourself on whatever you do BEFORE you do it when it comes to investing or finance.

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.

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.