One of my frustrations with common verbiage around stock investing is the plethora of gambling analogies. Common expressions include sayings like, “If you wish to play this sector.…” as if purchasing a stock is like playing a craps or blackjack table. Another common expression is to “go all in,” as someone would at a poker table. There is, “You have to know when to hold them, and know when to fold them.” And the ubiquitous, “Place your bets on….” In fact, “bet” is often used synonymously with “purchasing” a stock.
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There are some similarities between gambling and investing, but many larger differences. Both are pursuits entailing probabilistic outcomes involving risk and uncertainty. Participants can improve their outcomes in both pursuits by understanding probabilities. Skilled gamblers last a lot longer than unskilled gamblers, but with the odds stacked in the house’s favour, the outcome is usually the same. Both pursuits can be influenced, usually negatively, by emotions. Short-term investing is an oxymoron and is like gambling, as is the likely outcome. Most day traders are done within a couple of years.
Long-term investing is, however, a completely different pursuit, with the odds firmly stacked in the investor’s favour. While near-term results might be similar for both short-term and long-term investing strategies, the further into the future one goes, the larger the outcome differences.
The stock market goes up 56 per cent of days and down 44 per cent of days. If you allow me to round that to 55 and 45, I can illustrate with a simple analogy. The icosahedron is a 20-sided die invented in Roman times and repopularized more recently in the game Dungeons and Dragons. Let’s say you played against an opponent who won with the numbers one through nine (45 per cent odds) and you won with the numbers 10 through 20 (55 per cent odds). We have all played enough dice games like Monopoly or backgammon to understand that sometimes you get on a streak of big rolls and sometimes a streak of little rolls.
It would be easy to imagine your opponent being ahead after five or 10 rolls, simply by being on a streak of little rolls. However, after 100 rolls, it is unlikely your opponent would be ahead. And after 1,000 rolls, similar to four years of daily trading activity, it would be almost impossible for your opponent to be ahead.
Since 1926, the S&P 500 is up 56 per cent of days, 63 per cent of months, 76 per cent of years, 88 per cent of five-year periods, 95 per cent of 10-year periods, and 100 per cent of 15-year, or longer, periods. The data on individual stocks will be different as they exhibit greater volatility.
While my personal history with stock investing is much shorter at 30 years, I have never been negative over a five-year period. My portfolios went up during the 2000-02 bear market and I recovered in about three years after the 2008-09 bear. However, I didn’t live through the Great Depression, which represented the worst of the worst for negative performance statistics.
Even with long-term investing strategies, regular decisions must be made. It is important to understand the decision matrix for those decisions made in probabilistic pursuits. Not always do good or bad decisions lead to good or bad outcomes. When a good decision leads to a good outcome that’s good management. When a good decision leads to a bad outcome that’s bad luck, and when a bad decision leads to a good outcome that’s good luck. When a bad decision leads to a bad outcome, I call it, “Whad’ya expect!”
While some may argue that luck has nothing to do with it, we are constantly making decisions with imperfect information, and given the probabilistic nature, luck can affect the outcome of any specific decision. However, over a long period of time the good and bad luck balances out and those with higher percentages of good decisions will do better. Following a good decision process, always putting the odds in our favour and understanding the role of time are critical to success.
So, with all of this knowledge and data readily available, can anyone explain to me why the average holding period of a stock has continued to decline and is currently just five and a half months? How do people think they can stack the deck (another gambling analogy) against themselves and still win? Why do they create so much work for themselves?
If you wish to gamble … go to Vegas!
