As we draw near to the finals of World Cup 2010, if anything can be said about this tournament, it is that it has been full of unpredictable outcomes.
Who could have predicted that former World Cup champions, Italy and France, would be knocked out in the group stages, not to mention that both came bottom of their groups? Brazil, the bookie’s favourite to win, never made it past the quarter-finals. USA beat England to come top of their group and let’s not forget how England got everyone sweating till the very last minute.
But could the World Cup and betting on the winners (and losers) teach us anything about how we can become better stock market investors?
I would argue that it can. Both the stock market and competitive sporting games have in common two important elements: uncertainty and probability. In fact, we can draw some very important lessons for our trading from this year’s World Cup games:
- Think probabilities, not rewards. Walk past your local bookmakers and you’ll most likely see them advertising on their shop window how much you could win by betting on a specific match. “Bet $10, win $100”. This is the hook to reel you inside and make you place a bet with them. Never mind that the odds of you actually winning are low. However, the unaware speculator is too focused on cashing his big reward than to think about probabilities. The same is true in the share markets, where brokers prey on the ignorance of less savvy investors by selling them cheap worthless stocks or “penny shares”. Unaware investors gulp these up as they are mesmerised by the notion that the stocks are “cheap”, hoping they can make big gains when the share price goes up.
- Don’t underestimate the underdog. I wonder how many people quickly dismissed Uruguay and Ghana from ever reaching the quarter-finals? It’s always a joy seeing the underdogs playing against the major players. Almost everyone wants them to win, but few of us perhaps have much conviction that they will. Too many times I see traders that I mentor panic and close their positions because they “think” that the market is about to move against them. Then they watch with agony as the market races towards their intended direction without them. By allowing fear into the equation, based on no other evidence, they have just cut themselves from the opportunity of making substantial profits.
- Avoid personal biases. The desire for our countrymen to score seems to punch a hole in our ability to think objectively. The England vs. Germany match was such an example. Prior to the match, I heard some England supporters claim a 5-1 victory for their team. How ironic that almost the opposite result was achieved. If we could put a lid on our human emotional biases perhaps we could also become better stock investors. For example, in England, where I spend most of my time, I see many people completely ignoring the US markets. Most people invest in what they think they already “know”, sticking for decades with UK shares that have done almost nothing for them. Universally, most people seem to be risk-averse, afraid of doing something they don’t fully know about because they may “lose everything” than actually stepping forward and achieving something.
- Diversify your bets. At the start of the World Cup, almost every single online sports-betting service had picked four teams to be the most likely to win the whole tournament: Brazil, Argentina, Spain and Holland (in order of odds of winning). Interestingly, the winning odds assigned for each team were not that dissimilar (4.5:1 on average). As we now know, Brazil and Argentina were later ousted at the quarter-finals. Even so, what if we had applied the investment principle of diversification to our betting? What if at the very start we had placed equal bets on each of the four favourite teams? By the time of the Finals we would still be in a winning situation. Diversification is a useful principle in both markets and in life.
- Anything Can Happen. This World Cup has served us all by reminding us of how completely unpredictable the games can be. The uncertainty principle pervades life in much the same way as it rules the markets. Yet time and time again, I see people coming off stock market training courses, thinking that they are now able to peer into some crystal bowl, predicting the market’s every move. For these would-be traders, a lesson in humility is awaiting them.
As professional stock market traders, we don’t want to gamble in an uncertain market. So we want to trade only when the odds are in our favour.
I don’t consider myself a gambler – far from it. I generally stay away from highly speculative endeavours where the odds are stacked heavily against me. Sports betting is one of them. However, stock market investing need not be a gamble. It is our personal tendencies to ignore the rules of probability that make it so.