How I Turned $1,000 into a Million Dollars in Real Estate ...

Dien,

First of all, congratulations.

You gave the exact answer to the question: the stock market is alluring because of the element of addiction it shares with the games of chance.

But... you immediately corrected yourself.

'Of course, ladies and gentlemen, the stock market (like business) has it's 'rules' and 'logic''.

It's very interesting to play stupid with defenders of 'reason' and 'logic'.

So, let me play stupid and ask you:

'WHAT are those 'rules' and logic that the casino games LACK?'

My point is that if you try to 'reason' statistically, the odds of succeeding in business and stock market on the one hand and the odds of succeeding in casinos are the same.
(And please, don't refer to the so called 'success stories'; for every business-stock-market success story there is a story of lottery-casino winnings).

Just look at the marketers and business consultants using the metaphor of 'stacking odds in their favor'.

Implicitly they FEEL that the 'games' are essentially the same.

What are the odds of coming out with a successful book, succeeding in restaurant business etc..?

So, what is your answer to the stupid question?

Simon

> 'WHAT are those 'rules' and logic that the
> casino games LACK?'

> My point is that if you try to 'reason'
> statistically, the odds of succeeding in
> business and stock market on the one hand
> and the odds of succeeding in casinos are
> the same.

It depends what you call succeeding. If by succeeding you mean ending up with more dollars than you started with, then I'm pretty sure the number of stock market investors who succeed at that is much higher than the number of gamblers over a decent time period.

You can view casino games as logical because they follow a very defined set of rules. Playing them is a fairly illogical activity, however, at least from a profit perspective since the odds are always stacked against you.

The main difference I see between casino games and business or the stock market is that the latter two do not have fixed odds -- they depend somewhat on your skill, experience, knowledge, as well as luck.

The main difference I see between casino games and business or the stock market is that the latter two do not have fixed odds -- they depend somewhat on your skill, experience, knowledge, as well as luck.
---Thomas Rice

Thomas,

Thank you for replying to my crazy question.

Let me be even more stupid with you:

From my stupid perspective the fact that the business/market odds are NOT fixed only make things WORSE for the market player/business owner.

Just imagine throwing dice and suddenly it's weight, shape, the characteristics of the table are changed in the process.
Just imagine plying cards that change on you because of the weather, irrational character or bad news from China.

Virtually unlimited number of factors when you play an INDIVIDUAL stock make things worse than 'casino' activity with limited number of factors...

> From my stupid perspective the fact that the
> business/market odds are NOT fixed only make
> things WORSE for the market player/business
> owner.

I think it depends on what the odds are in each situation, though. With a casino, chances are over long periods of time you will lose money and there is nothing you can do to alter it.

With the market, chances are over long periods of time you will make money, even if you have no idea what you are doing, provided you diversify significantly.

Because the odds are variable in markets, there's opportunity there for people to add value in their investment decisions, whereas this is not the case with casino games for the most part.

>Just imagine throwing dice and suddenly it's
>weight, shape, the characteristics of the table
>are changed in the process.

Another way to look at this is to say that how predictable stocks are versus casino games is less. I'd say I'd agree with this, but focusing on this is only half the story. Apart from predictability you need to focus on average or expected returns.

For casino games, the results are fairly predictable -- your returns will be negative.

For the market, the results are more variable and less predictable, but you would expect your returns to be positive. Especially if you look over longer time periods and diversify.

>Just imagine plying cards that change on you
>because of the weather, irrational character or
>bad news from China.

>Virtually unlimited number of factors when you
>play an INDIVIDUAL stock make things worse
>than 'casino' activity with limited number of
>factors...

This is also a decent point -- there are a tremendous amount of factors that can alter the value of a stock. Weather can affect a lot of agricultural stocks and related industries, and news in China can affect a whole host of companies that have business there or deal with China, or their related industries.

With that in mind, I'd say if someone is not very familiar with a stock, they shouldn't invest in it alone but should get a balanced portfolio so mitigate those stock-specific risks somewhat.

Dien mentioned in a previous post that Buffett looks for predictable businesses to reduce those risks. I'd agree that that is one of the essential parts of his approach.

Basically the concept is, not all stocks or businesses are the same, and they differ in how predictable they are. To give an example, Coca Cola makes Coke and other drinks and sells it around the world. It has been doing it for a long time. They will most likely still be doing it in 2, 5, and 10 years time. I would say that they are more predictable than a start-up IT company developing a product it hasn't sold yet and hasn't tested yet.

So if you want to look at individual stocks, it is possible to try to look at stocks where you have an idea of all the major factors that can affect it, and where there are uncertainties and random elements -- like the impact on foreign exchange on a company is a common one -- you can at least be aware of what those random factors are and take them into account in your valuation. :)

A very good question, Simon.

One I had myself for a while. Then a while back I read “Trading in the Zone” by Mark Douglas. He compared trading to a casino. Odds to odds. Chances to chances. And said overall, this is why you lose at gambling.

But then… ah, the card counter. Takes him a while to figure it out, but once he has a system he can follow with discipline (the hard part), he can get the odds slightly in HIS favor over a number of trades. And not just because the market tends to go up over time. I’m talking about averaging over a number of 20/30/50 trades in a month.

“But the card counter gets thrown out once the casino discovers him.”

Yes, but there’s no security to throw out the slightly more experienced, disciplined player in the market. Douglas eventually moves past the card counter example and says the way to think about it is you want to BE the casino. Inevitable small losses and a few big ones, but with enough of an advantage to come out ahead over a period of time.

Thanks for starting this interesting thread, Robert.

Success,

Erik Lukas

P.S. Douglas’s first book, The Disciplined Trader, should also be required stock market reading.

P.P.S. I would also say that most people who try to play their hand at swings and scalps will lose. But there are a few who don't.

Hi Simon,

One thing you are very good at doing is asking questions that make people think!

You said,

"...If you try to 'reason' statistically, the odds of succeeding in business and stock market on the one hand and the odds of succeeding in casinos are the same."

I actually think the "odds" are probably not the same.... I think on average, in the stock market you will tend to make money, whereas in a casino you will tend to lose money.

For example, let's say you invest in the stocks that make up the Dow Jones Industrial Averages Index. In July 1936, the DJIA was 164.90. In July 2003, the DJIA was 9233.80. When you calculate it, that means that if you invested in the DJIA during this time, you got an "average" return per year of 6.19%. (It's not a lot, but you'd still be making money.)

On the other hand, let's say you spend your money in a casino. To take an example, let's say you're playing American roulette. With roulette, the odds are that for every $38 you spend, you will on *average* (over many spins) lose $2. That means that with each spin, you are on average losing 5.26% with every spin. On average, you are losing money, not gaining it.

(You can read more about roulette odds here - http://www.gambling-hall-online.com/roulette/roulette_odds.htm )

Therefore, it seems to me that odds of succeeding are not the same.... In the casino, on average you will lose money. In the stock market (at least with the example of the DJIA), on average (over many years) you will make some money.

There's a lot more to answer your question though, as a full answer of your question would have to be a discussion of what causes the price of a particular stock. Clearly there are a lot of factors which cause the price of a stock - how much the company is making in profits (or losses), the expectations of future profits (or losses), macroscopic factors (the general economy, currency exchange rates, interest rates), political events in the world, and so on. It's clearly very complicated.

What Warren Buffett seems to assume is that in the *long term*, the primary factor which creates the price of a stock are the net profits the company makes. He thinks that this factor is far more important in the long term than all the other factors.

Buffett then chooses stocks in specific companies which have qualities which make their future profits easier to predict with confidence. He chooses companies which have strong monopolies or which are "strong franchises" - which means it is difficult for other companies to jump in and compete with them. These companies are also generally less strongly affected by the various "macroscopic" factors too....

By doing this, Buffett can make "safer" investments in the stock market than many others. As I've mentioned before, in general I try to follow these kinds of assumptions too in my own investments.

If these assumptions are correct, then that means that at least for some stocks, future profits can be "predicted" with at least a degree of accuracy. From there, it's a matter of calculating what the company (and hence the stock) is "worth". If the current price is far below what it's "worth" according to these calculations, then it is "undervalued" and could be a good buy.

Well, there's a quick answer anyhow.... :)

- Dien

Casino games have odds. These odds are known. These odds do not change with the game. These odds are stacked - however slightly - in the casino's favour.

YOU, as an individual, might WIN, sometimes. BUT, of the total money spent over the course of an hour/day/week/month/year... the casino is the one who ends up with the most money.

NOTHING you do - play more and thus get experience, develop a system, keep track of and monitor past results, and so on - will change those odds.

IF there is a game where you can develop a set of skills and "beat the house" then the casino has a rule that says you are not allowed to use that skill. If you ignore their rule they ban you from playing. The casino wins in the end again.

There is an accepted truth that: four in five business will fail within five years - and - of those remaining businesses, four in five of them will fail over the next five years. In other words... over the course of ten years, only one in ten business will not fail.

Is this an accurate "truth"? How is this calculated? By the number of business that register and then the number that continue to pay their yearly registration fees?

If so, that is a misguided way to know whether a business failed. Maybe the business owner moved onto other things. Maybe they sold their business and the new owner decided to operate it under their own existing business name. Maybe the business owner forgot to re-register their business. Maybe the business never got started after it was registered because circumstances change. Maybe the business owner started a few businesses and decided to keep the most profitable and just shut the others down - even though they were profitable.

I look at all the businesses which advertise in my local newspaper. I don't see a 20% or even 10% per year drop off of existing businesses and new businesses jumping in. I see the same businesses advertising year after year after year.

I walk through my local shopping mall. I see some businesses come and go. But still nothing like the "failure" rate accepted as "truth." And besides... when the business goes I don't know if it is closing down for good or simply moving somewhere else. Some businesses do not put "moving to such and such" on their windows. While other businesses have "closing down" sales only to have "opening sales" a month later in the shop around the corner, or even the same shop!

The Direct Marketing Association is supposed to have claimed only one in one hundred thousand mailorder businesses survive/succeed. If true, are these "failures" included in the other "one in ten over ten years" claim? And what is meant by succeed?

All I'm saying is, the claimed failure rates don't really mean much without knowing how they are arrived at.

So how is business better than a casino?

First, you can win with the accepted failure rate. Just open ten businesses and one will survive - in theory.

Ben Suarez says one in seven mailorder products fail. And you might have to lose fourteen times before discovering your two successes. But when you do they will overshadow all the loses.

So even with odds of one to seven against you can still win. Eventually.

In the casino you can never come out in front eventually. Because nothing about the odds changes. And you can't do anything to change them. There is no "learning from past mistakes" with the casino.

For every business success you can show a casino/lottery success? Fine. How do those numbers rate when worked out on a per-capita basis?

For every ten million people who play the lotto, one wins. If the claimed business failure rate is applied to that ten million number then you will have one million successful and surviving businesses. One from lotto and one million from business.

Clearly, the random odds of succeeding are still with the business owner.

But business has changing odds. Things that mean times are good and times are bad - for the business - based on a myriad of reasons...

Weather - bad weather might keep people at home. Fewer people shopping means less sales.

Newspaper story - stories can cause people to want to buy certain items or to impose personal bans on certain items. Such as the boycott of French goods for the French government's recalcitrant ways over Iraq.

Wrong words in ads - using words like "collapse" in an ad shortly after 9/11 could have caused a decline in sales.

Changing market - sell lime green items and recent sales will have been good. But as the market's taste for color changes to pink, you will not sell as many of your lime green widgets. If you do nothing - and don't start making pink widgets - your business may suffer greatly.

Seasons - baseball season, hocket season, cricket season, etc. Interest increases when it's the "season" for that item. Halloween. Christmas. Easter. Fourth July. And so on.

Mood - people may go out more or stay home more depending on their mood. Feeling insecure caused more people to spend more time at home after 9/11. Video rentals increased. Live entertainment dropped off.

None of these things effect your ability to lose in the casino. But they do effect how profitable your business is. To stay profitable you need to be aware of as many of the things that influence your business as you can be, and make adjustments to your business accordingly.

The odds in business may change. But it is only truly dangerous if you do nothing about it.

As far as the stock market goes. Success, from my understanding of it, is more dependant on your investment approach.

Buy and sell (trading, day trading) is high risk and as about as guaranteed as placing bets at the casino. - Despite all the charting available.

Buy and hold is lower risk and requires analysis skills. Lack those skills and you might as well play a game at the casino.

Buy and hold index funds is also lower risk and doesn't require analysis skills. It also assumes the index will continue to rise as it has done previously.

If I had to choose between investing $5,000 in the stockmarket (even in an index fund) or using it to increase business, I would use it to increase business. What I then do with the increased profits is the topic of another discussion.

Thanks for your thought-provoking question(s).

Michael Ross


Brain food

Good post Michael! Just thought I'd comment on the following:

> Buy and sell (trading, day trading) is high
> risk and as about as guaranteed as placing
> bets at the casino. - Despite all the
> charting available.

> Buy and hold is lower risk and requires
> analysis skills. Lack those skills and you
> might as well play a game at the casino.

> Buy and hold index funds is also lower risk
> and doesn't require analysis skills. It also
> assumes the index will continue to rise as
> it has done previously.

I agree that day trading is high risk. Essentially when you invest in the market your total return is determined by the following:

1. The investment return for the investments you hold over the time you hold it
2. The transaction costs you incur
3. The taxes you pay

If you add no value as a day-trader, and you add no value as a buy-and-hold investor, then you'd expect the average return on the first point -- investment return -- would be roughly the same.

The key difference arises with the second and third points. Transaction costs -- namely, brokerage fees and so forth -- are significantly higher for traders than they are for buy-and-hold investors, and these commissions eat into the profit for traders.

With taxes, at least in Australia a buy-and-hold investor typically pays capital gains tax which is half the rate of the normal tax rate that traders would pay. This too has a significant effect on long-term profitability.

Before you think taxes are insignificant, let me illustrate with this example based on Australian taxes. If you used other countries, it might not be as extreme.

In Australia, the highest tax rate for people with high incomes is 50%. If you hold stock for over a year before you sell it you tax it at half the rate, or roughly 25%.

If an investor invests $10,000 for 10 years at 10%, they'll have $26,000 at the end, pay $4,000 in tax, and have just under $22,000 left over.

For a trader to achieve the same $22,000, but paying tax each year rather than at the end and at a higher 50% rate, they'd need to achieve a return of 16%. That's a big difference, and it doesn't even include the transaction cost effect yet.

> If I had to choose between investing $5,000
> in the stockmarket (even in an index fund)
> or using it to increase business, I would
> use it to increase business. What I then do
> with the increased profits is the topic of
> another discussion.

The stock market is essentially a passive investment. For the most part it's priced about right to give investors a modest return on their capital.

When you run a business, you'll have internal investment opportunities that may return much greater returns, and better yet, are exclusive to you to take advantage of. Thus, in many cases investing in internal projects is the way to go.

Stocks are mainly interesting, in my opinion, because the skills used to analyse or value stocks are the same used to analyse or value internal business investment opportunities.

- Thomas.

Just wanted to mention a few things about casino's--

It has been stated that odds don't change-
In blackjack they most definitely DO chage from hand to hand, depending on what cards are depleted.

The key is to know when the edge changes.
That is what card counting is all about.
It has been known from 1961 and was published by Professor Edward Thorpe in a book called Beat the Dealer.

There are many professional syndicates travelling around the world playing Blackjack fulltime, and it is well documented.

One of the most successful teams of all time was with Ken Uston--the Vice President of the San Francisco Stock Exchange in the 70's.

He chucked his job in after being taught by a high school drop out how to count cards. His 4.5 million dollars won in the 70's is documented in his book Million Dollar Blackjack. A film was made of his activities called the Big Player.

In roulette, there have been professional syndicates documented from the 1890'2 looking and playing biased roulette wheels.

Even jupiters casino on the Gold Coast has had biased wheel play against it.

Russell Barnhart has a fantasic book on the exploits of biased wheels in Beating the Wheel
and lists all the syndicates over the last hundred years that made a lot of money playing against biases.

Computers are also being used to predict the segment the ball will descend on....sort of like the orbiting descending formula's of Nasa.

Recently a Hungarian syndicate was expelled from the Sydney casino for computer play.

The first successful computers were used in the States by university physics students and is documented in The Eudaemonic Pie.

Poker is another game when the odds are changing depending on what has been played, and even linked poker machines/slot machines can give you an edge if the payout exceeds the odds as they can do if they are linked in a bank.

There are many ways to get an edge, and I havent revealed the mah jong syndicates that forced the Vegas casino's to stop offering the game.

Profit in uncertainty depends on odds AND payout.
Vaying either can provide a profitable situation if you know what you are looking for.

Going back to share markets--
I notice the best seller A Random Walk Down Wall Street by Burton Malkiel has been reprinted and is available in bookshops at the moment.
The premise is that a blindfolded monkey throwing darts could pick a portfolio that would make the same as an expert fund because the stock market abides by the random walk scenario in statistics.

And in fact, the mass consesus of the public so closely prices a share correctly, that the experts cannot consistantly outperform the public.

The updated book shows that if you had bought shares in an INDEX FUND and held them, you would outperform by 50% most traders.
That is why indexed funds have become so popular--a basket of shares in the Dow or All Ordinaries or whatever is the norm in your country--outperforms virtually any other fund over the long term.
In other words, it is incredibly difficult to out perform the public.

This is a brilliant book and I highly recommend it.

The term used is an efficient /semi efficient market, and it states that most of the information is contained in the price.
This is also the case in horse racing.

In any country in the world, the probability of the horse winning is fairly accurately determined in its price. A 2-1 will win roughly that anywhere in the world, and has done that even 100 years ago.
In fact, many studies show the similarity of semi efficient markets of horse racing and shares.

Professor Ziemba http://www.interchange.ubc.ca/ziemba/
has written quite a few papers on this.

So I think it's fair to say, that for some people, there is always an edge if you can see it.
But it depends on price AND odds to give the Expected Value (ROI).

Cheers

Tom

Ok, I will agree that odds do change in casino games. However, it still remains that overall the odds are against you, and things you can do to change this (using computers, card counting, etc) are banned in casinos. :)

It is true that payout and odds are both important, and thus odds can be in your favour from time to time (like with slot payouts), but I think it's fair that over time people lose money at casinos.

> The updated book shows that if you had
> bought shares in an INDEX FUND and held
> them, you would outperform by 50% most
> traders.

Yes, this is true, and I'd say it comes down to those additional costs traders have versus an index fund mentioned in my previous post. The one I forgot to mention is investment manager fees when you invest with a managed fund.

Index funds work on the premise that markets are efficient and managers don't add value, thus to maximise return you minimize fees by buying the index.

My opinion is that most fund managers do not add value, so it's important to find the few who do. :)

> The term used is an efficient /semi
> efficient market, and it states that most of
> the information is contained in the price.
> This is also the case in horse racing.

Yes, I'd say describing the market as semi-efficient (pricing in public information but not private) is fairly accurate. However I think it's a mistake to say that markets are *always* efficiently priced and more correct to say they are *mostly* efficiently priced, with occasional changes from the efficient price.

With that in mind, I'd say the trick with stock investing is to focus on the few companies you find that are away from a 'correct' price, and recognise that the majority are about right.

For those that haven't read already, I'm an analyst at a funds management firm in Sydney called PM Capital. Whereas most fund managers construct portfolios to mimic the index, and then modify their weightings to add value, we strive for an absolute return by focusing on the 10% or so of the market where valuations are out of line with reality, and thus don't have strong views or positions on the majority of the market.

I would say that PM Capital adds value as a fund manager, and is one of the few that does, but of course my opinion is biased. :) Long-term after-fee after-tax returns should show that, however.

- Thomas.




PM Capital