Yesterday I gave some examples of how the stock market is not a zero-sum game. But today I want to talk about one part of the stock market that is essentially a zero-sum game: out-performance.
The “price” of the S&P 500 is actually a weighted average of its component stocks based on market capitalization. In this respect, the performance of the overall S&P is a close approximation to the mean performance of all of its components. So for every stock that outperformes the overall index, there is one or more stocks that underperform the index by an equal amount. That’s how means work. That’s also how zero-sum games work.
I wrote an article a while back about luck vs. skill in the market. This article was based on the assumption that the stock market is a zero-sum game, which of course it is not. So in a bull market, the true measure of success is not actually making a profit, it is making a return greater than the return of the overall market. Likewise, on days that the market drops sharply, success can be measured by the relative performance of your portfolio. For example, on a day where the S&P 500 is up 1.5%, I might not be as happy about my 1% gain as I would be about my 1% loss on a day that the S&P 500 dropped by 1.5%. Consistently outperforming the market is always my goal.
But if out-performance is essentially a zero-sum game, what chance do small-time traders like me have against Wall Street? If there are thousands of “professionals” playing this game with nearly unlimited collective resources and experience, how would the individual “retail” investor ever win the zero-sum game and beat the professionals? Aside from the fact that many of these so-called “institutional” investors have absolutely no idea what they are doing, the good news is that small-time investors don’t have to win this zero-sum game by beating some guy in a corner office on the 12th floor at Goldman Sachs, they just have to beat the guy giving out free market advice at my apartment complex’s swimming pool.
As I was relaxing and enjoying the sunshine the other day, I overheard a conversation between a few fellas at the pool in which one guy was convinced that making money from stocks was simple. He was telling his friends, “All you have to do to make money in the stock market is find out when Apple and Google are releasing their next generation phones, buy stock in the companies before the phones come out, and sell after the phone buying frenzy that follows!” Simple as that. I suppose this genius fully believed that, after decades of people devoting their lives to predicting the movement of the stock market, he was the first person to finally crack the Da Vinci Code. Of course, as I have written previously, just because you can predict that a product will be successful doesn’t mean you will make a single dollar off of a company’s stock. That’s not how the market works. How the market does work is that, over time, it removes the money from the account of this poor guy and his friends, and it deposits it into the accounts of people who know what they are doing.
Unfortunately, there are plenty of people trading stocks that have absolutely no idea what they are doing. Some of them are gambling addicts, some of them are naive, and some of them are simply stupid. Trust me, I have talked to plenty of them, and, whatever the reason, they have no shortage of confidence.
I’m sure many of these people are kind-hearted, compassionate, successful professionals with adoring families. But the good news for me (and bad news for them) is, in the zero-sum game of market out-performance, all of them are losers. Small-time traders like me don’t have to beat the professionals on Wall Street. All we have to do to out-perform the S&P 500 is make sure we beat the pool guy, his friends, his relatives, and the thousands of other people out there trading the stock market that shouldn’t be.
Think the pool guy made some good points about Apple and Google? Do yourself a huge favor, and read my book before you end up frustrated, embarrassed, and/or penniless from trading the stock market. Or maybe you just want to be able to look sophisticated in front of your coworkers when they ask you what you are reading on your Kindle, and you’d prefer to tell them “Oh, I’m just reading a book about stock market analysis,” rather than the usual “Oh, I’m just looking at pics of my ex-girlfriend on Facebook.” For these reasons and more, check out my book, Beating Wall Street with Common Sense. I don’t have a degree in finance; I have a degree in neuroscience. You don’t have to predict what stocks will do if you can predict what traders will do and be one step ahead of them. I made a 400% return in the stock market (beating the return of the S&P 500 by an average of more than 25% annually) over five years using only basic principles of psychology and common sense. Beating Wall Street with Common Senseis now available on Amazon, and tradingcommonsense.com is always available on your local internet!
