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The Game — And Risk — of Stock Investing

Is there risk in stock investing? Yes. But if you learn to take control of your emotions you can learn to take advantage of risks in the stock market.

play cashflow now

The name of the game isn't avoiding risk but managing it

Google the term “SEC lawsuit” and you’ll find that the world of securities trading is full of crooks. Notably, in 2010, the SEC sued Goldman Sachs for failing “to disclose to investors vital information about the CDO, known as ABACUS 2007-AC1, particularly the role that hedge fund Paulson & Co. Inc. played in the portfolio selection process and the fact that Paulson had taken a short position against the CDO.”

Translation: Goldman tried to pull one over on investors investing for the long term while knowing that a hedge fund was ready to pull the rug under them.

As a result, Goldman Sachs paid a record $550 million in fines. Was that a lot for them? Not really. According to ProPublica, it was about two week’s worth of profit. A small price to pay for a calculated bet. In this case they lost: they only made $15 million in fees from the deal in question. But as ProPublica points out, “...keep in mind: Goldman did 25 of these so-called Abacus deals in all, and created many more CDOs without the Abacus label.” In short, Goldman got caught on one deal but will come ahead across all deals.

You against Big Firms: A big stock market risk

When I was a kid, there was a popular game called RISK. The game is set in the Napoleonic era, and you control an army and a section of the board. The goal of the game is simple: world domination. It’s a game without mercy and requires high intelligence and much planning. It’s not a game for suckers.

For decades, Wall Street has been playing their own version of the game RISK—and though the stakes are higher, the strategies are the same. The source of all this risk? Trading.

In Conspiracy of the Rich: The 8 New Rules of Money, I wrote about how those who play by the old rules of money—go to school, get a job, buy a house, save money, and invest in a diversified portfolio of stocks, bonds, and mutual funds—are playing to lose. This is especially true when it comes to investing for retirement in the stock market and Wall Street’s financial vehicles.

Why? Because you’re playing the game of stock market RISK against firms that have way bigger arsenals than you—and also have no problems with cheating—firms like Goldman Sachs.

When you never fall, risk is not an issue

When I was a young boy, my father taught me how to ride a bike. At first, he held onto the back of my seat and ran with me. Then, as time went on, he started letting go. Right before I would fall, he'd grab the bike to steady me. Then one day, he just let me fall.

Crying, I asked, "Why didn't you catch me?"

He replied, "If I didn't let you fall, you'd never learn how to stay up. Once you learn to identify what it feels like when you are beginning to fall, you'll be able to learn how to make the proper corrections not to fall."

I didn't understand at the time, but my father was teaching me a valuable lesson. You must learn from your mistakes to move forward.

Unfortunately, we live in a society where the rich kids on the street always have dad to prop them up and never fall. The little guys like you and me are left to fall. For years, the Fed has propped up rates for cheap money and propped up banks to keep them afloat when they make bad deals. Meanwhile, the average Joe is facing record inflation and big drops in the stock market.

The biggest problem with all these prop ups is that risk is eliminated, which causes more reckless actions. But until the true culprits feel the effects of the fall—instead of the little guys—the real problems causing the falls will not be fixed. People must learn to accept risk and take a fall in order to truly grow. I learned that as a child when I learned to ride my bike, falling many times.

Stock market risk and taking the fall

If you ask most people what their strategy for retirement is, they’ll say investing in the stock market for the long term through vehicles like a 401k and mutual funds.

Those who invest for their retirement in the stock market and financial vehicles made by Wall Street firms are betting on the market rising in value. They’re fed “facts” like the stock market returns 7-10% per year. They are investing for capital gains instead of cash flow.

Of course, playing the game of averages is risky. Why? Just ask the folks who were ready to retire when the Great Recession hit in 2008. Averages didn’t mean anything to them when their portfolios were wiped out. And as I wrote about recently, many retirees are now facing a prolonged bear market …maybe even a big crash. Years of gains could be wiped out right when they need them most.

Again, this is the average Joes taking the fall, not the big Wall Street firms. They know they can take the risks because you’ll take the fall

Stock market risk through trades

The problem is that the true money is made in trading—in the sell, not the hold. If you’re finally ready to retire and sell but the market has recently crashed, your average return means nothing. In fact, traders need the middle class to invest for the long term so that they can cash in on their financial ignorance through trades and fees—often highly complex trades that take advantage of market swings and that require a high financial intelligence.

All the major Wall Street financial firms understand that the real money is made in short-term trading, not in long-term investment. And the reality is that the higher the risk, the bigger the return. And big firms are willing to risk it all for the big payoff.

In a 2010 article in TIME Magazine called “The Case Against Goldman Sachs”, Stephen Gandel writes: “‘With a trader, the goal of every minute of every day is to make money,’ says Philipp Meyer, who worked for UBS as a trader in the late 1990s and early 2000s before going on to write about his time there. ‘So if running the economy off the cliff makes you money, you will do it, and you will do it every day of every week.’”

Of course, when I say that big firms like Goldman are willing to risk it all to make a killing in trading, I don’t mean they are willing to risk all they have…I mean they’re willing to risk all you have. These big firms are not just experts in trading, but they’re also experts in hedging those trades. The true victims are rarely the firms themselves—or the executives and traders collecting big bonuses—but rather good, hard-working investors with little intelligence.

The lawsuit against Goldman only existed because the SEC thought that Goldman hedged unfairly—not because they wiped others out. In reality, most people and organizations are just pawns for the big Wall Street firms in a much larger game of RISK—stock market trading edition.

The TIME article goes on to say: “In 1998, the year before Goldman went public, just 28% of its revenue came from trading and principal investments. By 2009, it was 76%.” And quoting a former Wall Street executive, "The industry became so heavily weighted toward risk, it just made sense to let the traders run things." The traders are in control on Wall Street—and they love the stock trading game of RISK.

The game of RISK—Stock Market Trading Edition

According to the RISK product website, the following are some suggested strategies to be a winner at the board game of RISK. The rules are very similar to the ones for the trading game of RISK played on Wall Street.

  1. Focus on the goal and the objective
    In the board game of RISK, the goal is total world domination, no mercy.
    The goal is the same in Wall Street trading. This is not a charity game. It’s a chew ‘em up and spit ‘em out, high stakes game where the winners win big and losers are toast. Big trading firms will not blink twice in wiping you out in order to make a profit. And they’ll cheat if they think they can get away with it.

  2. You must grow to win
    In the board game of RISK, you must grow a large army and accumulate large capital to conquer the world.
    In the trading game of RISK, you must also grow large. By doing so, you earn friends in the government who will overlook your unfair advantage, and you gain insider access to make smart financial moves powered by knowledge while the little guys go down in flames.

  3. Make large attacks
    Making small attacks in the board game of RISK is worthless. You need to make big, large-scale attacks to win. The risk is higher, but the payoff is worth it.
    In the trading game of RISK the rule is the same. Small trades with little risk are worthless. Why? Because traders make money in the form of bonuses based on the size of the trade. As the Time article I referenced earlier states: “As with everything else on Wall Street, the rise of the CDO had to do with bonus checks. Traders' pay was based not just on how much money they made for the firm but on the size of the bet.” In other words, traders have financial incentive to take bigger risks and are discouraged from playing it safe.

  4. Don’t hesitate to eliminate a player from the game
    When you’re playing the board game of RISK, there’s no room for mercy. Whether it’s your best friend from childhood or a random stranger, you have to treat all opponents the same—you have to take them out whenever you have the chance.
    The same holds true on Wall Street. As the old adage goes, “There are no victims on Wall Street, just fools.” Traders are merciless and will sacrifice you, me, the whole economy to make a buck for themselves and for their firm. They don’t have your best interests at heart—they have their own.

  5. Know the map
    The game of RISK website says this about the game: “New players are fresh meat with huge egos.” I translate that as, “People who don’t know the rules of the game will be eaten alive.”
    The same holds true for the stock market trading game of RISK. Those who have a low financial intelligence, who live by the old rules of money, will be eaten alive by the traders on Wall Street

Become confident at the stock investing game

People often come to me asking how they can play the game of stock investing better. One of the questions I ask is whether they know how to make money both when the market is going up and when it is going down.

For most people, the concept of making money when the market is going up is easy. However, many are stumped when thinking of ways to make money when the market goes down.

The answer lies in understanding the difference between fundamental and technical investing.

Fundamental investing

Rich dad said, “A fundamental investor reduces risk as he or she seeks value and growth by looking at the financials of the company.” For the fundamental stock investor, the most important consideration for selecting a good stock for investment is the future earnings potential of a company.

A fundamental investor carefully reviews the financial statements of any company before investing in it. He or she also takes into consideration the outlook for the economy as a whole, as well as the specific industry in which the company is involved, and the direction of interest rates.

Technical investing

Rich dad said, “A well-trained technical investor invests on the emotions of the market and invests with insurance from catastrophic loss.” For the technical investor, the most important consideration for selecting a good stock is based on the supply and demand for the company’s stock.

The technical investor studies the patterns of the sales price of the company’s stock, asking, “Will the supply of the shares of stock being offered for sale be sufficient, based on the expected demand for those shares?”

Playing the game of stock RISK like the pros

One of the reasons so many people think the subject of investing is risky is that most people are operating as technical investors, but don’t know the difference between a technical investor and a fundamental one.

Because stock prices fluctuate with emotions, technical investing seems risky to those who do not have a good financial education. They don’t understand fundamentals and have poor technical investing skills. And because they have no control over the direction of the companies they invest in, they’re susceptible to the whim of the markets.

  • They are on the outside looking in. If they don’t know how to read financial statements, they are totally dependent on the opinions of others.

  • If they can’t read business financial statements, chances are their personal ones are a mess too. As rich dad said, “If a person’s financial foundation is weak, his or her self confidence is also weak.”

  • Most people only know how to make money when the market is going up, and they live in terror of the market going down.

But with the right financial education, the reality is that both types of investing are not risky.

Play the game of investing with confidence

Rich dad used to say, “Investors need to be well versed in both fundamental analysis as well as technical analysis.” He would draw the following diagrams for me.

Fail Harder image

These diagrams are why Kim and I started The Rich Dad Company to develop products that help people become financially literate, and to teach their children to do the same.

With the right financial knowledge, understanding both technical and fundamental investing, you can invest confidently, knowing you can make money whether the market is going up or going down.

Know the rules to win the game of stocks

I want to see you win. In order to do so, you must understand the rules of the game. The only way to understand the rules is to increase your financial IQ. For instance, now that you know the rules of stock trading, you can begin to learn how to play by those rules. That may mean learning how to be a trader.

Rich Dad offers classes on technical trading and expert coaching on trading through our Rich Dad Education and Rich Dad Coaching programs. You may want to take advantage of those resources in the coaching and classes sections of this website.

I encourage you to stop playing by the old rules of money, and to instead educate yourself financially. Understand that the only person who can save you financially—is you. You can’t rely on the other players because their objective is to win—at the cost of you losing. You must rely on yourself and your mind. That’s why I preach that Knowledge is the New Money. You can only win if you understand how to play.

Original publish date: April 27, 2010

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