January 16, 2011

• The Game Show Day Trading/Investing are Most Like

  It occurred to me that the game show Deal or No Deal matches quite nicely with the concept of investing/day trading, albeit with a few slight modifications.

  

   

  In the game show (US version), there are 26 closed suitcases with varying sums of money from 1 cent to 1 million dollars. The contestant has to pick cases to open and as long as they don’t pick high amount value cases, they will be offered increasing sums of money – at which point they have to decide whether to take the deal or to continue to play, risking any amount previously offered. The game ends when either all the cases have been opened or the player accepts the offered deal and stops playing.

  With investing or day trading, you have a similar situation of changing values of your investment through out the day. If you are looking at 5 minute price bars, one can say that a “suitcase” of value is opened every five minutes at which point you have the option to close your position and take the deal, or wait for another suitcase to be opened. The key difference here is that the suitcase values can be negative or positive with negative values reducing your account and positive values adding to your account.

  The length of the game depends on whether one is a day trader or long term investor.

   

  Day Trader Game Ending Possibilities:

  1) Person chooses to exit.

  2) Person loses all their money and is forced out.

  3) Market is closing and trader is forced to exit all positions for the day.

   

  Long Term Investor Game Ending Possibilities:

  1) Person chooses to exit.

  2) Person loses all their money and is forced out.

   

  Notice that for the long term investor, the game can continue indefinitely as long as they don’t go bust. This is where the added benefit and higher risk of long term investing over day trading is revealed. Long term investors have the benefit of time to recover from any losses whereas the day trader is forced to take any losses by the close of the day.

  The danger in long term investing is that one is making the assumption that one’s investment will recover, whereas that may not be the case. While the day trader has limited their loss to one day, the long term investor is vulnerable to continuous accumulated losses day after day.

  Long term investing also carries the risk of market conditions changing over time that will impact one’s particular investment. Given enough time, it’s almost a guarantee that any current good investment will eventually fall out of favor.

  Long term investing risk can be mitigated by exercising the “choosing to exit” option, which the masses rarely do….at least not under desirable circumstances. Most people exit when they are panicking due to market turmoil. The better way is to take some profits when your investment is making new highs rather than lows. The strategy would be to sell a portion when the market is moving higher, and then repurchase when the market pulls back. Risk is further reduced if there is an exit strategy to guard against severe losses in case of a protracted market downturn.

  This obviously requires the individual to pay more attention to their investments and not just forget about them, as most people tend to do.

   

   

  • 1:19 pm
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