This will never work (Vol 1, No.8)
There is a fine line between investing and gambling. For most retail investors, buying a stock is really no different than betting on your favourite number on the roulette table.
Things in common – math and statistics
What they both have in common is math. There’s a bunch of statistics that we can fall back on. We know what the long term stock market returns are like and we also know what are the odds of the winning at baccarat. But what we don’t know is what will happen in the short term?
Key difference – Positive versus negative long term returns
What’s different is that in investing, the longer you stay invested in the markets, the more likely you are to see positive returns. On the contrary, as the odds favour the house, the longer you gamble, the more likely you are to see negative returns.
For instance, we know that from 1987-2017, out of 7,659 trading days, the Hang Seng Index had risen 52% of the time. We also know that the average 1.08% gain on those Up days outweighed the average down day’s -1.072% correction and the resultant average +0.046% daily return compounded nicely over time.
Conversely, in the gambling sphere, with rolling chip win percentage around 2.7-3.3%, compounding works in the favour of the casinos.
What’s funny about that?
Hang on a minute here, isn’t the title Friday Funny? This lecture doesn’t sound funny at all.
Well, the whole point of the above is just for me to introduce this YouTube clip. It’s from three years ago but doesn’t feel dated at all. This goes out to my Singaporean friends.
Update on “Mean Reversion”
On a more serious note, the stock market has continued to misbehave.
In mid-February, in the wake of the market sell-off that erased 10.6% over 13 days, we ran some numbers and basically gave a non-answer to whether stock markets were due for a bounce (see link here).
Two months and 48 trading days have passed and we are pretty much back where we started. The Hang Seng Index bounced back from 29,540 to as high as 31,601 (up 7.0%) and has since fallen back to 30,008 (5% retracement).
Does this mean that we have “mean reverted”? Is the volatility over?
Up Days to Down Days – The ratio of Up Days to Down Days has gone from 19:11 to 45:33. As up days still make up 58% of 2018’s trading days, this is still above the long run average of 52% and suggest more rainy days may lie ahead.
Daily Percentage Change – Thankfully, the amplitude of the down days have moderated somewhat. Instead of falling an average of -1.277% (over the first 11 down days), the average down day has now moderated to -1.176% (over 33 down days). At the same time, the average gain on the up days have picked up from +0.673% (over the first 19 Up days) to 0.883% (over 45 days).
My suspicion is that our earlier advice to develop a hobby as a coping mechanism to deal with higher volatility still stands. If not, there’s plenty of funny stuff on YouTube.