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Tuesday, March 3, 2009

Is Investing In The Stock Market Like Going To Las Vegas?

Some people say that there is no difference between investing in the stock market and gambling in Las Vegas. This is a happy fiction for casino owners, but unfortunate for casino gamblers. It means you might be tempted to "invest" in blackjack or poker, instead of stock or bond mutual funds. In this article, we compare the similarities and differences between casino gambling and stock market investing. Make up your own mind if they are the same kind of investment.

What casino games have in common is that the gambler has a very small chance of winning any single hand, be it roulette, blackjack, or slot machines. For instance, there are 38 numbers on a roulette wheel, and, if you bet on a given number, the rough odds of winning a single game is, 1 in 38, or 2.6%. This means, of course, that the casino has a whopping 97.4% probability of beating you! This is great for the casinos but not so great for attracting gamblers.

Fortunately for the casinos, the likelihood of winning or losing in the short term is not that clear at all. Wins and losses in any casino game follow a random sequence of winning streaks or losing streaks, which cannot be predicted in advance. A long sequence of losses (a losing streak) can bankrupt a gambler, while a long sequence of wins (a winning streak) can generate huge gains.

When a gambler gets on a losing streak, he attributes it to bad luck. But something in human psychology needs to attribute a winning streak to superior gambling skill, instead of just good luck. In reality, they are neither skill nor luck. Winning and losing streaks are demonstrably random, unpredictable events.

To understand this, consider a simple coin toss game, where everyone knows that there is a 50% probability of getting either heads or tails with each coin toss. But many people would be surprised to find that if they tossed the coin many, many times they could get a lucky streak of say, nine heads in a row. It’s hard to believe, but it’s true, and you can try it for yourself.

Toss a coin many times and write down the outcome; you will see that 4 to 9 successive heads or successive tails will occur pretty regularly. These sequences are a graphic demonstration of "streaks". If "heads" represent a win and "tails" a loss, we can see winning streaks and losing streaks even in a simple coin-toss game.

So you can see that there is a way to beat the casino if a gambler hits a "winning streak" of 4 to 9 consecutive wins, leaves the table, cashes out and runs. But if he gets on a "losing streak" he’d better pack it in, accept the loss, and leave the table immediately before more damage can be done.

Gambling is fine for someone who wants to play with cash for the entertainment value, but it is not for the investor who wants to make some serious money.

The odds of winning in the stock market are incredibly more favorable. During a bull-market of rising prices, your odds for making money on any given day are 66.7%! Contrast that with the 2.6% probability of winning at roulette! On the other hand, during a bear-market when prices are dropping regularly, you are likely to lose money 66.7% of the time. So even during a bear-market you are losing less than you would in a casino.

And just like in casino gambling, there will also be winning and losing streaks with many consecutive days where the money comes pouring in, and many consecutive days where the money just seems to evaporate.

But if you knew ahead of time the periods when a bull or bear market is likely, then you could make adjustments in how you invest, so that you could maximize earnings or conserve money and prevent losses.

For instance, if a bull-market is likely, you would invest in stock mutual funds, and then sit back and watch the 66.7% odds of success pull the portfolio higher. Conversely, if a bear-market is likely, you would pull the money out of the stock market and into the safety of Money Market funds, then sit back and watch the market get hammered with the 66.7% odds of losing.

This system works because Market Timing Indicators (see website listed below) can be used to predict whether the environment is favorable or not for future stock market gains. This is unlike casino gambling where there are no indicators and every round is unique, so that the odds of winning are unknown,

These ideas are the very essence of long-term market timing, as practiced by the author in his FREE newsletter at www.predictableinvesting.com. By side stepping the awful 2000-2002 bear market, and reinvesting near the bottom in June 2003, the simple one fund portfolio has grown to 411% of its original value in just over 11.5 years. This system beats a buy-and-hold approach hands down and has made 81% more profit.

NOTE: This is a clarification for my math and science savvy readers. The statistics used to calculate the odds have been intentionally simplified to make the article readable for the average non-technical reader. If you want a fuller explanation please email me at Sanjoy@PredictableInvesting.com.

By : Dr. Sanjoy Ghose
Dr. Sanjoy Ghose spent his 40 year career in technology research and development of computer storage devices. He was a senior executive at several well known California Silicon Valley companies and startups. Since his retirement from high-tech, he has been publishing his FREE newsletter on investing, a subject he has studied and followed extensively for over 16 years. To find out more, please visit www.PredictableInvesting.com

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