Investing in the stock market is like playing that game of rock-paper-scissors

By | January 12, 2019

Rock-paper-scissors is a game that nearly all of us played as children.

It is a game with incredible opportunities to play mind games with your opponent.

There is no luck in rock-paper-scissors as with card games.

The game does not have complex rules like chess.

You simply have to figure out the patterns of your opponent (or induce patterns into them) and take advantage accordingly.

Can you beat the New York Times computer bot?

Back in 2011, the New York Times created a rock-paper-scissors playing computer bot. While the game may seem like simply a game of chance, it is very difficult to outsmart the computer. In fact, every time it seems like you detect a pattern in the computer’s moves, the computer is actually figuring you out and slowly beating you.

I remember losing to the bot by quite a wide margin when I played against it when it first came out in 2011. I’m convinced that I was not unlucky against the computer.  I believe the computer had detected patterns in my moves, even as I was trying to either decipher a pattern in the computer’s moves or induce the bot to make a predictable move.

The more I tried to “trick” the computer into playing scissors when I was about to play rock, the more likely the computer knew that I was going to do this and play paper instead. It’s remarkable how good computers can be at playing one of the purest games of wit and deception.

How to never lose at rock-paper-scissors

It turns out that while it is very, very difficult to devise a strategy or build a bot that can win the game of rock-paper-scissors (or maximize the advantage against suboptimal players), it is just as easy to play the game of rock-paper-scissors in a way that will not lose to anyone, not even the best players or computers in the world.

You simply have to randomly choose between rock, paper, and scissors. If this happens, no matter what strategy your opponent chooses, you will win, lose, and tie exactly 1/3 of the time. As a result, you will never lose to your opponent in the long-run. Of course, you also will never win.

Index investing and rock-paper-scissors

Investing in the stock market is like playing that game of rock-paper-scissors. The default strategy is buying the entire investing universe (the total stock market index). Index investing is like randomly choosing between rock, paper, or scissors. It is a strategy that ensures you will never lose to the market. You will always get the market return, no more, no less.

Once you deviate from an index investing approach, you are now using a strategy that you think will beat the market. You may try to do your homework in order to find the next Amazon or Starbucks. You might search for dividend-paying stocks, or technology stocks, or only buy stocks in the spring or winter. At the extreme, you try your hand at trading in and out of stocks, thinking that you can forecast the future of the U.S. economy or read stock charts.

Once you start trying to beat the market, you introduce opportunities to make the errors that erode your returns. These errors can be investing in a tax-inefficient way (e.g., trading in taxable accounts). It can be spending long stretches of time out of the stock market in a futile attempt at market timing. It can be investing in a high-cost actively-managed mutual fund, a usually futile attempt to find someone who can beat the market.

Conclusion

A buy-and-hold index fund investing strategy is the simple strategy that ensures you will achieve the market return. It’s like randomly choosing between rock, paper, or scissors. Since winning the investing game is mostly about not losing, index funds have been the key to success for many, many investors.

“Wall Street Physician,” a former Wall Street derivatives trader , is a physician who blogs at his self-titled site, the Wall Street Physician.

Image credit: Shutterstock.com


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