Backgammon and the Stock Market


The following is a guest post from the Dividend Ninja. A couple of weeks ago, Y&T mentioned she was going

back to school full-time, and was worried about not being able to write enough material while studying (which is a valid concern). She was asking for guest posts – how could I say no to a fellow Vancouverite?

A few months ago I downloaded backgammon app on my Blackberry to play when I’m really bored and don’t feel up to reading or working on the web. Of course I chose the “Expert” level since I think I’m a pretty savvy player. I also figured it would be pretty easy to beat a basic game of backgammon – especially since it’s a just a blackberry app (if it was an iphone app I’d think twice). Well beating the game wasn’t as easy as I thought! And even more difficult as I discovered, is to consistently win a number of games in a row.

So what does that have to do with the stock market? You might be surprised to find out more than you think.  Many investors approach the stock market and their investing strategies like a game of backgammon. Here’s why gambling and investing shouldn’t have anything in common, but as we often see for many investors they do.

I Feel I Can Win

Backgammon Pictures, Images and Photos

Feeling positive or negative about a game of backgammon before it begins has absolutely no influence on the outcome of the game. Sounds silly doesn’t it? But many investors apply this logic to investing. They buy stocks or make decisions based on their feelings about a particular stock or the market in general. The bottom line is your feelings about a stock or the market in general, has no effect on the outcome. For example, right now I think Pepsi (PEP-N) is a good buy. Does that really mean it will influence the outcome of the price?

The luck of the Dice

The main factor in backgammon of course, is simply chance itself, the luck of the dice. This is simply the result of random events, which adds an element of unforeseen risk. As soon as you decide to play the game, you take on the risk of receiving bad or good rolls, winning or losing, and everything in between. I can be as calculating and as careful a player as I can be – scrutinizing every move I make. But in the end it’s all pointless if I get unlucky rolls and my opponent gets 3 double-sixes in a row, or vica versa. In other words chance will influence the game enormously.

In a similar vein, there is much more chance and random events which occur in the stock market. Sure the markets move in waves of high and lows, but even the academics and pundits can’t tell you what the market is going to do tomorrow or next month. There is simply no way to know what the market will do from one day to the next. Simply put the events of the stock market, and stock prices for that matter are random. If it wasn’t everyone would be wealthy, because the market would then be predictable.

Defining Risk

What I did notice was anytime I took a chance and left my pieces open, or made an aggressive move against my opponent (a dumb blackberry app) I ended up getting behind and often lost the game. So I determined that in backgammon, regardless of dice-rolls or “ability” of my opponent, taking chances rarely pays off. That means that risk in backgammon comes from taking chances.

The stock market of course is far more complex than a simple game of backgammon. The levels of risk in the stock market are many and varied, and layered in complexities. I have come to the simple conclusion that when you take a chance in the stock market, your outcome is more likely to be a loss than a win. That’s why it’s important to have a strategy in place, whether that is passive index investing or passive dividend investing, that you apply in a logical and unemotional way.

Improving the Odds to Win

Can you improve your odds of winning in backgammon? If risk in backgammon is associated with taking chances, then what if I eliminate that possibility? So I changed my tactic and decided to play the safest games possible, by not taking undue risk. In other words I always played the safest moves possible.

While employing that method certainly improved my number of wins, it certainly wasn’t a deal breaker. I still ended up only improving my wins only marginally over time. So what does this indicate? It indicates that calculating your moves and trying to make a decision on every move, has no real effect on the outcome of the game. While it sounds absurd, picking stocks and paying constant attention to the market, or on the details of specific stocks, is also meaningless. Really, it is.

Why Logic Doesn’t Work

What about eliminating any chance and always playing the most logical move, as determined by mathematical odds? Surely that is the deal-breaker! If one only had to apply pure logic and math to backgammon to win, then that would be a no-brainer. In fact this is exactly what the blackberry backgammon app does, and probably with some human moves programmed in, but it doesn’t win every time! This is simply the result of the unknown. It is impossible to know what dice-rolls the future holds, or what moves your opponent or yourself will make in the future.

In similar vein it is impossible to know what the stock market will do one day to the next, or a month from now. You may purchase a stock at 52 week lows, with great fundamentals, and there is no guarantee. Yet you may take a chance on a stock and make a 300% gain over the year. Once you realize that the stock market has no possible logic that can be applied to it, and is completely irrational, the less likely you will be to bet against it. After all if the market was based on logic, then all the mathematicians and physicists would be millionaires and the rest of us would live our lives in poverty – but it doesn’t work that way, does it?

It’s Impossible to Consistently Win

The other possibility of course, is that it is impossible to consistently win in backgammon. In other words the more times you play, the higher your chances of losing. That means there is a large element of chance, and that playing it safe doesn’t always pay off, and taking a risk rarely does. Consider that the stock market is even far more complex than a simple game of backgammon, and you can see why taking a chance in the markets is a loser’s game!

So what’s the solution? Simply resign yourself to the fact that if you play backgammon you cannot consistently win every time. Forget about playing the game at all, and buy your opponent! In other words buy the market instead of betting against it. That strategy is called index investing.

Index Investing with regular contributions, something Andrew Hallam points out in his new book Millionaire Teacher, is one way to beat the game. He also reiterates this point in his recent post in MoneySense magazine.  By employing this strategy you simply take all the guesswork out of investing. And of course one of the best resources for Canadian Index Investors is the Canadian Couch Potato.

Passive dividend investing is another strategy that takes the guess work out of investing, and I reiterate the word passive. Purchase solid dividend paying blue-chip stocks, regardless of price, with a set-it and forget-it attitude. Reinvest your dividends (DRIPS) and compound your returns. A passive dividend strategy will pay off many years down the road in terms of ROI (return on investment).

The following was a guest post from the Dividend Ninja. Thanx for reading!

About

Young is a writer and former owner of Young and Thrifty and the main "twitter' behind Young and Thrifty's twitter account. She lives in Vancouver, BC and enjoys long walks on the beach, spending time with her anxious dog, and finding good deals. If you like what you read, consider signing up for email updates.

22 Responses to Backgammon and the Stock Market

  1. Thanks Dividend Ninja! Ever since I saw your site, I just loved the way it looked and I loved your content. It is an honour to have you guest post on my site (my frazzled student brain is forever indebted to you for it ;) ).

    I too have suffered from the gambling addiction of investing in risky plays in the stock market and sometimes have this ego thing where I ‘think I can win’. I have resorted now to just buying dividend stocks or just indexing it. It takes wayyyy too much time and effort to be researching stocks or the “next big thing” and wayy too much mind-energy better spent elsewhere on speculating :)

    I love the Canadian Couch Potato website and I also love that Andrew Hallam has recently put his entire portfolio in three indexes :)

  2. Y&T my pleasure! Thanx for the awesome comment.

    Well we have all made that mistake, haven’t we? I’m holding three positions I would rather not be for exactly these reasons.. a couple of previous income trusts and a U.S. tech giant. They are small positions fortunately. However I’ll hold and collect the dividend income for now and wait for the future growth :)

    While I like the concept of indexing, definitely you cannot beat the dividend income stream from those nice blue chips – Passive Index Investing and Passive Dividend Investing is the way to go :)

    Cheers
    The Dividend Ninja

    • @The Dividend Ninja- I agree.. I think we all have to play a little backgammon sometimes though- just to realize what you did wrong and what you can learn from it… otherwise we’d be wanting to play the market all the time :)

  3. I love the way you made a connection between Backgammon and the stock market!

    Emotions are your enemy when it comes to investing. Both indexing and passive investing takes this out of the equation. Your chances of success are much higher than trying to time the market. Simple logic actually!

    • @My Own Advisor- he actually approached me :) I think both Dividend Ninja and Andrew could see the desperation in my posts about how little time I have to work on my blog these days.

  4. Great comparison! I completely agree that the market is not a rational animal. I’ve read about how a few hedge funds on Wall Street have made a ton of money in the past decade just taking out a huge number of long-shot options. Basically, they are betting that most people underrate the probability of “black swans” or events that radically shake up the stock market. People want to believe that if they follow a certain strategy, they can’t fail. It’s amazing how many people convince themselves that they can out smart all the other money-managers out there.

  5. That’s an interesting comparison. I think regularly contributing is the key factor to winning in the stock market too. Dollar cost averaging over the long term (30 years) remove a lot of the risks. The only individual stocks I buy these days are big dividend stocks and that should help stabilize my portfolio.

    • @retirebyforty- Ditto for me (or not buying anything at all, in my case.. I’m definitely not as active as I have been in the past). Are you an indexer, Joe?

  6. Every creative way of explaining the futility of trying to outwit “Mr. Market” helps people learn the difference between investing and what is essentially gambling. I’m putting your Backgammon analogy in my tool kit to use with prospective do-it-yourselfers. Thanx.

  7. While I understand the comparisons that you are trying to make, I don’t think they really apply to backgammon.

    First, chance in backgammon is overrated. Download gnubackgammon and you will understand what it is like to play against an opposition that always makes the optimal move. The end result is winning like 1 in 100 games. In fact this program dried up professional backgammon games as good players became so good that they would crush amateurs at too high a frequency.

    Second, risk is required to win in backgammon because short-term risk will lead to better long term outcomes. The perfect example is that it is sometimes better to blot (leave a piece open) to provide a greater probability for your next role.

  8. Hi Ninja,

    Y&T must have some serious pull to get both you and Andrew on board to do guest posts :) It’s nice to see you on yet another great blog.

    I like the analogy you use in this post. If there’s anything consistent about the markets, it’s the inconsistency that we witness day in and day out.

    As you mention, if we all knew where the markets were heading for any given time frame, we would all be a lot wealthier by now. Taking the time to employ a sound investment strategy aimed for the long-term is of paramount importance.

    Great job!
    TWC

  9. Hey TWC you found my secret hiding place :) Thanks for visiting me over here. Great comment man, I especially like this:

    “If there’s anything consistent about the markets, it’s the inconsistency that we witness day in and day out…Taking the time to employ a sound investment strategy aimed for the long-term is of paramount importance”

    Cheers

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