Wall Street Craps – 2012 Global Ebook Finance Award-Winner

DON’T TRY TO PLAY THE PRO’S GAME: Professional stock investors (big-time hedge-fund, mutual fund, and private equity managers) are usually well-diversified over dozens of companies in several different industries. While potential returns are always a strong consideration in their evaluation processes, the accurate assessment of risk is equally important to them.

But it’s worth remembering that the professional stock investor who manages other people’s money as an occupation is really in the business of getting and keeping customers by having superior performance relative to their competition. They are also paid to maintain positions in the stock market and to spend most, if not all, of their new inflows of money on additional stock purchases. What the pros are not paid to do is hold their customers’ money in cash or cash equivalents for an extended period of time. And unfortunately for professional public investors, they have the added pressure of having to report their performance and stock positions on a regular quarterly basis.

On the other hand, individual investors are only in the business of satisfying their own needs on their own timetable. They’re not in competition for any customer money. An independent investor can learn how to buy stocks and manage risk like a professional, without having to report their actions and results to anyone outside themselves.

This means that as a savvy independent investor, you don’t have to spend most or all of your money on stocks in order to play the game. You have the option of holding large amounts of cash for any length of time, whenever the risk/reward ratio doesn’t appear attractive enough for you to invest.

DON’T PLAY LIKE AN AMATEUR: When it comes to investing in the stock market, most under-capitalized amateurs seem to be in a constant search for the ideal stock. Since this is a difficult thing to do with any level of certainty, the amateur will tend to pick only a small sampling of stocks in the most popular sectors of the market.

What often happens to amateur stock players is that they develop a special liking to only one sector of the market – such as technology, gold, or energy. In doing so, these naive investors are not spreading their risk over enough different companies and industries to handle any unforeseen problems that may be unique to that issue or sector of the stock market.

As a novice fresh out of college, I served as the classic example of an amateur investor who was focused on only one industry. Since I had very little stock market experience at that time, I was heavily influenced by whichever analyst or advisor communicated with the highest degree of conviction. For me that person was Joseph E. Granville, a maverick stock market advisor who strongly recommended gambling stocks in the late 1970s. Like most of his followers at that time, my stock portfolio became too heavily weighted in gambling issues. As a result, I got caught in the nasty stock market crash of January 1981 that was triggered by Mr. Granville’s famous “sell everything” announcement.

In retrospect, I see that I made the mistake of thinking that diversification was a sign of not knowing what to buy. I didn’t understand the deeper wisdom behind lowering risk by diversifying assets in a wide variety of areas. As a young man, I was too focused on getting the highest possible returns. At the same time, I was almost completely unaware of the corresponding risks involved with incorporating that kind of investment strategy.

Of course, we all have the natural desire to own the single best stock over the near term so that we can make the most money in the shortest period of time. Yet the indisputable fact remains that no one really knows for sure what that would be. Instead, amateur investors are suckered into following those advisors who cater to our craving for certainty by giving us the most convincing story about their favorite stock or market sector to buy.

In order to succeed at stock market investing over the longer term, an investor must move beyond the unwise idea of owning the stock of just one company in a single industry. The stock market has historically proven to be too uncertain for risking all of your money in just one company. Instead, the proper course of action for investors is to spread their risk over several companies in a wide variety of industries and sectors of the market.

A Savvy Investing Take: The winning formula for successful investing in the stock market can be simplified into three steps: (1) confine your selections to a well-diversified list of top-performing high-quality stocks, (2) buy them when they are undervalued and under-loved by the public, and (3) sell them when they become overvalued and over-loved by the public.

If you choose to speculate in anything else, make sure that it only represents a tiny portion of your portfolio. That way, those positions won’t make you lose your primary focus or cause you to take a major financial loss. If you don’t possess the discipline to follow this advice, then you’re better off not playing the stock market at all.

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Consistent winning in the stock market requires that you buy correctly. You can accomplish this by purchasing investment vehicles that collectively make your portfolio diversified, liquid, and attractively valued. In a game built around the elements of uncertainty and probabilities, the stock market must be played with close attention to both risk and reward. The natural habit to avoid is the unsound practice of maintaining a concentrated investment portfolio – the kind of portfolio that leaves investors open to excessive and unnecessary financial risk.

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“Behold the fool saith, ‘Put not all thine eggs in one basket’ – which is but a manner of saying, ‘Scatter your money and your attention’; but the wise man saith, ‘Put all your eggs in one basket and – WATCH THAT BASKET.’”

Mark Twain ~ American author & humorist (1835-1910)

game:

1. a contest or sport involving skill, chance, and/or endurance that is governed by a set of specific rules.

2. a competitive activity where skill, strategy and luck contribute to outcomes, and which serves as an amusement, diversion, or interesting pastime.

3. a simple, yet profound way of understanding how investors invest their money in a challenging activity requiring a set of knowledge, skills and strategies that need to be understood and mastered in order to come out a consistent winner.

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“Investment is a game, and calls for the same qualities required to win at any game. You have to love the game and have an intense desire to win. Whatever strategy you follow, you should follow three rules: Be thorough, tough-minded, and flexible.”

John Train ~ Author of Money Masters of Our Times (2003)

stock market:

1. a regulated exchange where public securities are traded between buyers and sellers.

2. also referred to as “Wall Street,” which is the actual location in New York City that is regarded as the financial center of America.

3. a financial game of risk and reward that favors those who possess discipline, decisiveness, specialized knowledge, and keen awareness.

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“I believe the true road to preeminent success in any line is to make yourself master in that line. I have no faith in the policy of scattering one’s resources, and in my experience I have rarely if ever met a man who achieved preeminence in money making – who was interested in many concerns.”

Andrew Carnegie ~ American industrialist & philanthropist (1835-1919)

asset allocation:

1. the process of intelligent decision-making regarding the placement of financial assets for investment purposes.

2. the ability to move financial assets from one investment class to another, based on prudent risk/reward evaluations and individual investor objectives.

3. the critical decisions that savvy independent investors must make regarding where to put their money and in their proper amounts in order to play Wall Street Craps successfully over time.

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“True diversification is hard to achieve. The major portfolio building blocks tend to move in the same direction at the same time. That severely limits the protection that diversification affords. Recognize that the building and deployment of cash equivalent reserves is probably your best diversification tool.”

Robert Metz and George Stasen ~ Authors of “It’s A Sure Thing” (1993)

diversification:

1. the act of placing money in a number of different investments in order to reduce the risk of overall poor performance caused by having too much money concentrate in any one investment.

2. when investors spread money around in a variety of investment classes in an effort to create more safety and less volatility in their results.

3. what many part-time amateur stock players fail to create when they concentrate their bets on the stocks of too few companies, industries, or market sectors in the naïve effort to achieve greater financial gains.

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“Behold the fool saith, ‘Put not all thine eggs in one basket’ – which is but a manner of saying, ‘Scatter your money and your attention’; but the wise man saith, ‘Put all your eggs in one basket and – WATCH THAT BASKET.’”

Mark Twain ~ American author & humorist (1835-1910)

TAKE CHARGE OF YOUR OWN MONEY MANAGEMENT: When it comes to managing your money, the primary rule is to take charge of it yourself. Don’t make the critical mistake of delegating the responsibility of money management to someone else because in far too many cases delegating means neglecting.

I know that the whole concept of money management may appear at first to be too complex for average amateur investors to understand and do effectively. The good news is that it really isn’t.

The basic fact is that investing for the long-term is easy. On the other hand, trading for the shorter term is hard. All you have to do in order to simplify your money management strategy is three things: (1) put at least 80% of your money in a balanced portfolio of stable long-term investments, (2) set aside no more than 20% of your funds for trading purposes, and (3) remember to have plenty of cash available so that you don’t feel unnecessary pressure to make money quickly in order to pay current expenses.

By following the discipline of a well-designed money management plan, you will be able to let your assets grow over the long-term. You’ll also remain flexible enough to take advantage of short-term opportunities as well as meet your current expenses. Remember, when it comes to achieving financial wealth, nothing is more important than choosing a wise money management strategy to consistently follow over time.

NEVER WIRE HOME FOR MORE MONEY: Don’t borrow money or dip into your long-term security assets for the purpose of speculating. Understand that making money in the stock market is never a sure thing and sometimes you’ll be flat-out wrong. Face the reality that sometimes you will win and sometimes you will lose. But at the same time, don’t make the foolish mistake of thinking that success in the stock market is just a matter of luck.

The major cause of consistent failure can always be traced to either: (1) playing the market incorrectly, or (2) managing your money unwisely. The smarter alternative is to take a health break from the action in order to clear your head, learn from your mistakes, and refine your approach to suit your individual situation. Then you can carefully rebalance your asset allocation plan to desired cash levels in order to play again at another time.

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Note: The game of casino craps is a perfect illustration of how strong the desire is to get back to even after sustaining a loss. But this desire comes from an unhealthy emotional source which boils down to the need to be right. So it’s smart to set a rule for yourself that you will never wire home for money when your gambling in Las Vegas and you’ll never dip into your “security assets” to fulfill your trading urges.

REACH FOR YOUR WALLET: Don’t play with a short stack of chips. When necessary, reach into the cash reserves of your trading funds account and replenish your chips to a comfortable level. That way, you will relieve the pressure caused by playing with scared money.

Like the $5 player at a Las Vegas Craps table who is on an extended losing streak, it is really hard to play smart when you only have a few chips left in your tray. What often happens when players get low on short-term trading funds is that they impatiently go “all-in” with one giant bet on a single stock. This unwise impulse to boldly go “all-in” has an uncanny way of resulting in a total loss of capital.

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Note: This also means that if your chips get down to super low levels, it would be wise to cash out, move to the sidelines, and regroup. That’s because playing the stock market with scared money almost always leads to disastrous results.