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THE WALL STREET CASINO - TEN TRADES TO AVOID

Casinos are interesting places. I’ve visited Las Vegas on business or pleasure at least a dozen times but have yet to lose any money. It’s not because I’m a great poker player, or because I’ve found the secret to beating the slots. 

It’s because I don’t bet. Okay, that’s not quite right. Several years ago I was asked to witness a deposition. Believe it or not, the subject of the deposition insisted that it be held in the conference room of a casino just outside a small town in Iowa. The subject was late to the deposition, so I decided to kill the time playing $40 on some slots with the attorneys and a court reporter. Within about ten minutes I hit a jackpot worth over $1,100, and immediately cashed it in while being curiously questioned by a representative of the federal government who wanted to know how I was going to record the winnings. 

But I’m not a gambler. I only participate in things in which I have a clear advantage. If I don’t have an edge, I simply don’t play. The bright lights and exciting atmosphere just don’t do it for me. I see no entertainment value in losing my hard earned money to anyone or anything, period. 

You see, despite what they insinuate, casinos always have an inherent advantage, known as the house edge. So before you take your next trip to Vegas, you should know which games offer you the best (or worst) chances of winning. 

Slots are the worst. Attempting to pinpoint the odds for slot machines can be a daunting task. Machines can be set to whatever odds the house desires, though there are supposed to be federal laws that require the house edge to never exceed 30%. Typical slot machines will have an edge from 3% to 20%. Casinos have to be careful to not get too greedy or they will find an empty casino floor. Active slots translate to more foot traffic, which in turn means more people migrating to the table games.

Originally casinos would place their higher paying machines in high traffic areas like entrances, bars, and near lines for buffets and shows, anywhere a crowd of people was likely to be. The strategy of course was to place these “loose slots” where they would generate interest from passersby, making others more likely to play at average or lower paying machines. It didn’t take too long for slot players to figure it out, so casinos shuffled things up. Today loose slots are placed at random or in a secret arrangement that only the casino management and staff are privy to. Online casino slots have house odds of around 3% - 5%, as online operators don’t have the overhead burden that brick and mortar casinos carry. 

Of all the table games, craps and blackjack possess the smallest house advantage, around 1%. Of course if you become skilled at counting cards you may be able to actually reverse the blackjack odds slightly in your favor, but casinos don’t look favorably at card counters. Baccarat has a 2% house edge, followed by roulette and poker at 4%, sports betting at 5%. The game you should avoid at all costs to your wallet? Keno, at a house edge of 25%. Yikes. 

Wall Street has become a casino. They have done a fantastic job of capturing the average investor with the high tech online trading platforms full of promises of big payouts and lifestyles of the rich and famous. Bright colors, flashing lights, and alluring bells are used to entice the novice into playing today’s stock market games. 

Understand the big boys play the games to their advantage, an advantage that would make keno look tame. The trick of the trade is to know the games they play in which you have little chance of winning. Now don’t get discouraged. There are games you can play that place odds in your favor. But they are few and far between, and definitely not advertised by those on Wall Street. 

But before we get to those games I want to give you a list of stock market “games” you should avoid at all costs. These are investment traps that may provide great short term entertainment and excitement, until you realize your chances of winning are slim to none, and Slim just left town (with empty pockets).

The Top 10 Wall Street Casino Games To Avoid 

1.  Day Trading

Day trading typically becomes more popular during bull markets. Most day traders find it to be highly entertaining, if not addicting. To be fair many day traders earn gross profits before transaction costs. But studies show that over time most day traders, especially heavy day traders, lose money trading. The transaction costs finally get them. Less than 20% of day traders earn profits net of transaction costs. Do you like 1:5 odds of winning? Not to mention the physical and emotional toll that day trading has on a person. Day traders age quicker than first term Presidents.

 2.  Initial Public Offerings

What could be better than getting in on the ground floor of a start up? Maybe it’s the fact that when a company comes public it’s not actually a startup. The company started five years ago in the conference room of some venture capitalists in Silicon Valley. You, on the other hand, are the cashiers who these first floor guys are trying to cash their chips into. Studies have shown the price of the stock goes up around 20% in the first day of public trading. That would be a fantastic return for one day’s work. The problem is that the 20% move is typically made in the first few minutes of trading, and Joe Q Public can’t get their hands on those shares until all the big boys have bought (and probably sold) theirs. By the time you have an opportunity to purchase shares of what has surely been touted by the company’s publicists as the next Google or Facebook the stock has already made it’s run, and then things get pretty dicey as those fortunate to be up 20% in just a couple of hours now need someone to unload their shares on. That’s where they need you to finally come in and cash them out, and that’s when the stock can get pretty dicey.

Take for instance the Facebook (FB) IPO of May, 2012. By the time you would have been able to purchase shares of Facebook on the first day of trading, you would have paid just over $42 per share, a ten percent premium over the IPO price.

If you would have held those shares for three days you would have been down 26%, for another nine days down 39%, and over the next three months over 50%. Now I’m not saying you should never own an IPO. Facebook in fact has been an outstanding investment over the past four year. What I’m saying is you might wait until the IPO is a distant memory and the casino crowd is long gone.

3.   One Trick Biotechs

Outside of a very, very few large bio-techs like Amgen (AMGN) or Gilead Sciences (GILD), playing biotechs is a risky proposition, especially the one trick ponies that are riding one or two miracle drugs.

Take for instance Sarepta Therapeutics (SRPT).

On July 19, 2012 they announced something about one of their drugs and the stock exploded from $3.80 to $8.50 in one day. A couple months later they made another announcement and the stock went from $15 to $40 overnight. Sounds fantastic, right? Not so fast. A few months later they made another announcement and the stock went from $36 to $13. In one day. How would you like to put your hard earned money in SRPT?

If you have a need to play the biotech space, try an ETF of a basket of biotech companies. Granted it may not be as exciting to own, but you will sleep better.

4.   Unusually high dividend stocks

This one is tricky. Dividend stocks are an excellent investment. Studies show that the consistently higher paying, low beta large caps outperform non-dividend or low dividend paying companies over the long haul. But then there are those companies with ridiculously inflated dividends. Studies also show that these high payers invariably drop in price. There are reasons they are paying out large dividends, and none of them are ever good. A couple of years ago Cliffs Natural Resources (CLF) was paying a dividend that was four times higher than any of its competitors in the coal space. The 12% yield was tempting, but if you would have placed your bet in the coal producer your stock would have dropped 75% in just over a year. A 12% dividend can’t make up for a 75% drop in price.

5.  The VIX

The worst investments in the stock market are the exchange traded funds that trade the volatility index, or supposedly trade the index.” Don’t get me wrong.  The VIX, or fear gauge as many call it, is an excellent trading tool used to determine market sentiment. The exchange traded funds that track the VIX are not. The prospectus of the most popular fund, the iPath S&P 500 VIX Short-Term Futures (VXX), actually admits it is riskier than unsecured debt securities and that it has no principal protection. Yikes. The issuer, Barclays, has no obligations. It goes on to say that the performance is unpredictable, it is not actually linked to the VIX Index as everyone believes, and that any benefits from any rise or fall in the level of the VIX Index is limited. No wonder the product has averaged a 65% annual loss since its inception. Some may argue that trading VXX (short term futures) or similar instruments on a short term basis can be profitable. I say why trade something that eventually is heading lower, unless you have the expertise to short it?

6.  Bitcoins

Seriously? This little darling may eventually make it as an alternative currency, and one you might, underline might, eventually use to make some online purchases. But investing in it, really? Talk about gambling, this one is like playing the lottery.

7.    Trading in front of Earnings Announcements

Just like IPO’s, playing in front of earnings is exciting and fun. The potential for your stock to move violently the morning after the earnings announcement is a big lure. The problem is knowing which direction it might violently move. I receive countless emails from courageous souls who hold their stock through a solid earnings report only to see it sell off on the news. They want to tell me about the earnings beat, the increased sales, their superb market share, or their rock star CEO.

They just can’t understand how or why their stock is suddenly down 20% in the aftermarket. For me I learned my lesson many years ago in my dumb trading days when I regularly played in front of earnings. But after suffering a $65,000 loss in Green Mountain Coffee after the company reported and the stock gapped down 25% in a matter of minutes, I was forever broken from playing this game of roulette. Because I never trade in front of earnings of course I miss some exciting opportunities to make money. But I also miss the opportunities to lose not only my shirt but my much needed sleep.

8.  Trading on insider information.

Yes, it’s illegal. That should be reason enough to never trade on insider information. Ask Martha Stewart. Many people still do it anyway. I would encourage you to not trade on insider information not just be- cause you could go to jail, but because it’s seldom useful information. You never know whether it’s true until after the fact. And just because you have a piece of information that may move the market it doesn’t mean it will, or that it will move it in the direction you hope. There is perfectly legal and helpful information regarding what insiders- directors and officers of a company are doing with their personal stock. The people running the show must disclose when they buy or sell stock in their company, and those trades can speak louder about a company’s value than any press release. You can find this information online with just a little digging.

9.  Illiquid Stocks.

In my book any small companies that can’t get more than 100,000 of their shares traded each day is trouble. No liquidity can lead to wild fluctuations and price manipulation. There is usually a reason no one is trading shares in a small company, and that reason is not good. I’ve witnessed small company stock prices swing wildly over 80% in one day, and it could be devastating if you are on the wrong end of that swing. Stick with the liquid stocks, and wait on the small caps to grow up some before jumping in.

10.   Pump and dump.

One of the oldest tricks in the book is the old pump and dump. A slick salesman touts the virtues of a company as the eighth wonder of the world, enticing you to buy it. Behind the scenes they are simply attempting to pump the price of the stock they own so they can sell at the highest price possible, leaving you holding the bag of an overpriced stock. These salesmen come in all forms from cold calling professional scam artists sitting in some call center in New Jersey, to supposedly unbiased stock analysts in an interview on CNBC, to hedge fund managers on Twitter singing the praises of their newly bought darling that they believe should double over the next year. What they say is well rehearsed and makes all the sense the world, but just like Hillary’s growing email explanations, eventually runs out of reason and into the absurd. Don’t listen to anyone who is in love with a stock. In fact, my interest begins to peak in those companies that are getting trashed by everyone in the media, and yet its stock price quietly goes higher. Now there’s something to consider owning. 

So folks, don’t lose heart. There are a few sound, profitable Wall Street games you can learn to play that can provide you with consistently excellent returns. You will have to really dig to find them. There is no free lunch here. You might start by studying the big players, the ones who have been making consistent money in the stock market for many years. Understand these guys don’t advertise. They don’t write books and they never give seminars. They are very secretive about their edge. But studying their actions in the market can probably point you in the right direction. 

So if you feel like gambling, set aside a really small amount of money you can afford to lose and go knock yourself out buying some biotech IPO with your bitcoins. But when you’re ready to put some real money to work, avoid the lure of the Wall Street casino games.