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quite possibly the greatest investing parable ever

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June 13, 2009 – Comments (3)

This evening I'm going to enjoy a nice cold beer and a movie, I didn't invite anybody over or anything, I'm just going to let the brain idle down to zero workload and relax.  No 10Qs, no stock screens, no pondering fair value for my holdings, no

But first I thought i'd share the investing parable that starts David Dreman's book "CONTRARIAN INVESTMENT STRATEGIES:  The Next Generation".  "beat the market by going against the crowd" is Dremans tagline on the front cover. 

This parable and the basic teachings in the book (which are every bit as simple as low p/e, low p/b, low p/s, low p/cf work) are the foundation for the strategy I have applied to this bear market.  Seek out stocks that are severely out of favor, have good valuations, and do your best to filter future bankruptcies out of the mix.

The story is strange, perhaps, at first read.  Who would let it end the way it ends?  But after 6 months on the market I can see that Dreman is right, the story does end that way for many investors.  I will forgo further commentary and just post the story.  I hope its interesting or helpful to someone else.  Buy the book and admire the simplicity of its teachings. 

 Imagine you are entering a deluxe, well-appointed casino. Off the lavish entry foyer, there are two ample gambling wings, one hued in reds, the other in muted greens. The red wing looks enticing, but if I may insist, let's first enter the less crowded green rooms to watch the action.

The atmosphere is unhurried, the blackjack tables are sparsely attended, and every player sits behind a mound of green and black chips. You think at first you've come to the wrong place. You see the ordinary table limits, the ordinary clothes, the ordinary games. But then how did these ordinary people get such piles of money?

Then it comes to you. They're all winning. In fact, as you walk around the green wing, you hardly can find a losing player. You know, of course, that the average house take on table games is 5%, but as you count winning and losing hands, you realize these players are getting a better break. They seem to be gaining at a rate of 60% to 40%. You start fresh and take another count. The results are the same.

A pit boss appears at your shoulder. "Excuse me," you say, "but can this be right? The
odds favor the players?"

"Yes, indeed. The odds in the green room usually run 60 to 40. It's been that way since we opened."

"But...most of the players must go away winners."

"They sure do. At those odds, we calculate that 9,999 out of 10,000 make money. At our high-stakes tables in the back, they do even better, with winners running about 20,000 to 1. It's a good thing we get so few players, or they'd break the house."

Somewhat amazed, you thank him and shake your head. There's no time to lose, you decide, but
you'll need more than the few dollars you have in your pocket. You hatch a plan to gather your life savings, come back to the casino, and win the bundle you've been dreaming of.

On your way out, you glance into the red wing. The action level is much, much higher. The room is crowded and fairly roars with excitement. Can it be even better here, you wonder? Curious, you go
in. Players bet multiple table positions, wave frantically for change, entreat the gods for luck. You see few green and black chips, fewer winning players. The piles of chips in front of them are dwindling with each hand. In fact, the odds are worse than normal. Again, you start to count.
Although the players continue to excitedly toss in their chips, the odds appear to be maybe 60 to 40 in favor of the house. Once more, your curiosity whetted, you walk over to a pit boss and ask her the odds at these tables.

She tells you what you suspected. They are 60 to 40 in favor of the casino. Warming up to the subject, she chuckles and says, "This room coins gold for the casino, the chances are 9,999 in 10,000 rounds that we wind up winners." You don't have to be a genius to see that this is obviously not the place you want to be.

You go home and get your stash. You return to the casino with your fistful of money, excited, eager for action, all the time figuring how you'll do even better at the game. But then a strange thing
happens.

You walk into the red wing and start to play.

3 Comments – Post Your Own

#1) On June 13, 2009 at 12:48 AM, DEALWITHTHEDAY (43.65) wrote:

I have done alright this year. I did not have the opportunity to read this book yet this is the only way that I could figure out to make any money with this market. The odd thing this year is I seem to do better when the marke stays around zero using this approach or a very similar one. I am not try to pat myself on the back as I know the market can make you look just as foolish the next session. But I wanted to say thanks for the post as I was feeling like I was different did not quite fit. I call this my 1/2 Bull, 1/2 Bear approach as I did not have a name.

Again thank you.

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#2) On June 13, 2009 at 10:09 AM, TSIF (99.96) wrote:

Similar findings Deal.  (good name for checklist's parable).

Although I'm probably 60 green, 40 red.  My core picks are my longs and doing very well.  My 20 or so "bets" complement each other nicely. If one is having a bad day, another is doing well. I wish I'd caught onto the game last August.  I let a lot of my winners go on stop losses on the November crash and then again in January. Some of them went on to triple. I am learning to be very light on my stop losses and ride my winners longer. Mr. Market serves up some strange pitches, you have to be willing to take a swing at them no matter how they seem to twist.  Good luck.  Good post checklist. I hope that beer was refreshing. I did similar last night.

TSIF

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#3) On June 14, 2009 at 10:29 AM, LongTermBull (93.00) wrote:

I am going to have to look this book up. 

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