Stock Investing and the Game of Risk

The Game — And Risk — of Stock Investing

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.” In short, 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 no problems with cheating...firms like Goldman Sachs.

Stock market risk and your retirement

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.

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 were 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 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 theirs.

  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

Know the rules of stock market risk to win

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 Wall Street, 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