Investing on the Edge
If you want to generate real wealth, you’re going to need an edge
The Casino: Deviously Profitable by Design
“Running a casino is like robbing a bank with no cops around.” -Ace Rothstein
Casinos are designed to take your money- all of it.
There are very few winners in the casino system, and those winners are there for marketing purposes. Customers need to know it’s “possible” to win, this keeps them coming through the doors and coming back for more even after they lose.
Blackjack, Slots, Roulette are all games, but the games are rigged. 99% of people have lost before they pull that lever or spin the red and black wheel of doom.
As soon as they walk through the doors, their money is already owned by the casino.
For those seeking a little entertainment, this is simply the price of admission. But for the truly addicted, their kid’s college tuition, rent money, even their hopes and dreams, all become property of the casino.
It’s all a game. Both players are hoping to win the game, but one has an “edge”- one of the players has an unfair advantage.
It’s like competing in a drug tested Olympic event where everyone is clean, except the one athlete on the advanced, State sponsored doping program. That guy is juiced to the gills and nobody else stands a chance.
If you knew that was the case, you wouldn’t want to compete in that event. You wouldn’t play that game because your chances of winning would be very slim.
Yet millions do play this game, and they get destroyed.
This isn’t actually an article about the moral hazards of the gambling industry- not at all. In fact, Casinos can be a great business and understanding how they make money, can help you make money too.
Casinos Never Gamble
“There is a very easy way to return from a casino with a small fortune: go there with a large one.” -Jack Yelton
Casinos are businesses and businesses invest capital.
The casino is investing boatloads of money into fancy buildings, machines, flashing lights and huge buffet tables. It’s basically one giant honey pot designed to lure people in, take your money and then move you out the door to make room for the next person.
With all that money casinos borrowed from the banks, invested into construction and overhead, could they just leave their profits to chance?
Of course not!
Casinos, along with the banks and investors that fund them, are only willing to put up the money because they know that the casino has an “edge”, or, an advantage over it’s customers.
This is also what venture capitalists look for before investing into a startup. What unfair advantage does the startup have over it’s competition that will help ensure success? What is the moat that makes their business position so defensible?
In the age of software, many of the casino’s games are computerized. It can tweak the odds, win percentage and even the algorithm that controls how those wins and losses are metered out to keep the player hooked on the game for longer periods of time.
An Edge Cuts Deeper over Time
“The contemporary casino is more than a gambling destination: it is a multifarious pleasure enclosure intended to satisfy every member of the family unit.” -Colson Whitehead
With an edge, time is on the casino’s side. The longer it can keep you playing the game, the better it’s odds of winning, and the more money you will lose.
The Magic Coin Toss
Imagine you had a magical quarter. It had a 1% higher probability of turning heads than tails. If you only flipped it 5 times, your winning odds wouldn’t be that much different than a game of chance. Your special coin wouldn’t look so special.
But what if you flipped it 10,000 times?
Over time and all those coin tosses, that 1% edge would start to be revealed. Given enough flips, that small 1% advantage would become a major powerhouse. This is how a casino game works.
Roulette: The Magic Wheel of Doom
With just the addition of a few additional spaces to the roulette wheel, the casino’s odds are pushed above 50/50.
At first it seems like by just betting on red or black, you have 50/50 odds. But the casino needs an edge to run a business, and so it added in the extra green 0 and 00 to the wheel. This small adjustment gives it a 5% edge over you, the player, and over enough time, the game will take every last cent.
Or, if you play 1 number, you have a horrible 1/36 chance of winning (although it pays out 36–1). If the casino is basing it’s business revenue on those odds, they are probably not good odds for you.
The Blackjack Hijack
The casino has an edge of just .5–1% or so here depending on how well you play.
This is another key point. If you don’t play with proper strategy and mechanics, the house edge is even higher. In blackjack, the house edge can climb to 2–3% against novice players.
The longer you sit at the table, the more money the house will pull out of your wallet. The free drinks won’t help you either.
A smaller number of bets exposes you to less risk because it’s exposing you to less of the casino’s knife edge.
In fact, the casino prefers more frequent, smaller bets.
If you were to sit at a blackjack table and bet $1,000,000 on one hand, they wouldn’t like that very much. However, if you flip that around and say you want to bet $1 per hand, 1 million times, every casino in the world would take that bet.
$1,000,000 as a one time bet is a huge risk for the casino. Since there are not enough hands played to work their edge, they could lose $1,000,000 or make $1,000,000. They don’t like those odds. It’s like gambling and the house doesn’t like to gamble, it wants to bet on sure things.
If you bet $1, 1 million times, it’s a mathematical probability the house will take your money. They like those odds.
A Sure Bet
“The public’s out there throwing darts at a board, sport. I don’t throw darts at a board — I bet on sure things.” –Gordon Gekko
As you can see, Casino’s are not gambling. It’s a business. There is a system in place to virtually guarantee they will take your money, especially given enough time.
The customers walk in and throw darts at a board, the casino is betting it’s money on a sure thing.
Most investors are like people walking into a casino. They are throwing darts at a board and they get obliterated. The odds are stacked against them by professional investors and they leave their money on the table.
As you can see, the reason is clear, they have no edge.
Some people would say the stock market is “rigged”. Warren Buffett doesn’t seem to think so.
“It’s pretty hard to rig 20 trillion-plus dollars.” –Warren Buffett
Sure there are shady practices that some money managers and funds engage in. There is insider trading, there are high frequency trading bots and more that can make it all seem rigged, but overall it’s just too big to rig.
That being said, the market itself is still made up of millions of people and an army of robots all out to take your money. It’s a zero sum game. This could be said of most markets. Without an edge it’s quite hard to compete.
Many investors will tout risk management and psychology as key’s to success, but that wouldn’t work in the casino would it? It might help for sure, but over time, the house would still win with its edge.
Whatever you are investing in, you want to know that over time, you are going to make money.
Finding Your Edge
“You need to have something to motivate you, something to give you an edge.” -Tim Tebow
Investors need to think like the casino, not like the gambler. Investors need to develop an edge. This will allow the investor to consistently pull money out of the markets over time.
Finding an edge in stocks is difficult, but there are many paths to the same end.
“The most valuable commodity I know of is information.” -Gordon Gekko
Information has long been a powerful edge on Wall Street. Traders and investment firms go to great lengths to get valuable information- both legally and illegally. Knowing something other’s don’t is a huge advantage.
Information can also be more subtle. It may not be information that is directly pointing at something to buy, but instead, allows a trader to indirectly “see” an investment or a market differently from everyone else.
Thinking of stocks like a zero sum game, you can understand that if you buy a stock thinking it’s going up, someone else is selling it to you (maybe even shorting it) thinking it’s going down. Someone is going to win, and someone is going to lose.
If you are trading a breakout, there is a trader trading a reversal against you. Depending on what the stock does, one of you will make money and one of you will lose.
In the end, money was not lost, it was transferred. It changed hands from the traders without an edge, to the one’s with an edge.
If both the buyers and sellers are just throwing some technical indicators up on the screen looking for a signal, then there is no edge. Both traders are using basically the same set of tools.
Good traders are thinking of the stock market more like poker. They are not gambling, they have found an edge. Much of that edge is thinking about who is on the other side of the trade and exploiting a weakness.
Much like poker. It’s not just the hand being played, it’s who is playing it. These traders have endlessly tested strategies to find their edge against other players.
They probably started with an off the shelf strategy and technical indicators that everyone else used and then refined it. They built their own toolbox of what works consistently for them and then exploited it in the markets.
Warren Buffett has his own edge, built over time to suit his own investing style.
A lot of it simply has to do with the time he puts into researching the stock, reading financial statements and doing the work nobody else wants to do. He discovers value while everyone else just sees the price.
This allows him to buy stocks at or below their intrinsic value and hold them over time. His other edge is the relationships and leverage he has developed over time which allow him to make the best use of capital.
“In the short run, the market is a voting machine but in the long run, it is a weighing machine.” -Benjamin Graham
Much like the casino, Buffett extracts his profits over time, buying excellent companies cheaply when most sellers are distressed.
Paul Tudor Jones, who is more of a speculator than an investor, also developed his own edge over his many years trading futures, often not even holding his positions more than a few hours.
Both of these men have starkly different approaches to trading and investing, but both have made billions with their own unique edge.
Most of the public doesn’t even know they need an edge or what an edge is. This is what made the cryptocurrency market so easy to beat for so long.
Professional traders piled into the markets and were competing against novices that had never traded anything before. It was like being a professional at a poker table with a bunch of whales. It was hard to lose.
As more good traders, institutional money and futures piled into the crypto market it became much more mature and harder to beat.
In options the same rules apply to stocks, but you also have the edge of volatility. Many options traders will short volatility exclusively because the odds are often stacked in their favor.
If you are selling a credit spread on XYZ when XYZ’s Implied Volatility Rank is at 99%, then you know that 98% of the time, XYZ’s implied volatility is lower than it is today.
The odds are good that it’s implied volatility will soon be lower. When implied volatility drops, so do the price of the options you just sold. You keep the difference when you buy them back.
This is just one of the ways options traders look to exploit an edge in the markets based on who is on the other side of the trade.
Real Estate investors and flippers develop their own edge over time. Unlike digital assets where you are staring at a screen, real estate is more of a people business.
Investors are looking for a return above and beyond the what the real estate market provides. They are also “competing” with other investors for inventory.
For house “flippers”, an edge could be opening up channels to more deal flow (more potential properties to buy). If I can get more opportunity than other investors competing against me, I can buy more deals and make more money.
A powerful edge can also be found in capital inflows. If I am a house flipper and I have access to more capital (money) than my competition, I can afford to buy more deals without using my own money, and thus make higher profits with less risk than my competition.
And finally, a powerful edge can be found in networks. Some house flippers I have encountered possess a scarcity mentality. They feel the pie is not large enough to go around and so they horde knowledge and resources in an effort to reduce their “competition”.
Real competition is not reduced in this way, it is only strengthened. The best house flippers I know open the floodgates to others.
Sharing knowledge, resources and tools that make them successful is in their DNA. In return, they get access to more deals, credit, capital and labor that helps them to scale their business far beyond that of their competition and maintain that scale with less work, higher returns and far less risk.
Once they are operating at scale, it becomes very difficult for their competition to topple them. Those investors with the scarcity mentality are eventually reduced to minor players in the market.
Giving to others is perhaps the most powerful edge there is. It’s massive leverage and can be built into your business model.
“The world is like a reverse casino. In a casino, if you gamble long enough, you’re certainly going to lose. But in the real world, where the only thing you’re gambling is, say, your time or your embarrassment, then the more stuff you do, the more you give luck a chance to find you.” -Scott Adams
The key point is that if you want abnormal returns in investing or business (or almost any critical endeavor), you need an edge.
If the average investor wants to get the same returns as everyone else in the stock market for example, they will often just put money into some Index fund and forget about it. A 401K also falls into this category- average at best.
This might give them a market average return (around 7% or so) over the life of their investment. Some people would consider this return acceptable.
But what if an investor wanted a consistent 15%, 100% or even 1000%+ returns on their money? What if they wanted to make more money within a shorter time frame?
They can no longer do what everyone else is doing, the math won’t support that. A 7% return would not be able to provide the velocity required to reach their goals. They will need an edge and the confidence and faith to execute on it.
Taking the time to develop an edge is not for the faint of heart or the average Joe investor. It’s for doers, tinkerers, and extremely driven individuals that are looking to compete and win in business or the markets.
It takes a lot of work, discipline and dedication. It also often takes a bit of risk-taking, but the rewards can create market beating returns.
If you don’t have an edge, at best, it will be incredibly difficult to consistently generate market beating returns. At worst, you will eventually lose all your money.
Make it Happen
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Disclaimer: This article is for educational purposes only and is not a solicitation to buy or sell securities or an offer of personal financial advice. It is offered with the understanding that the author is not engaged in rendering legal, tax, accounting, investment planning, or other professional services. It is suggested you seek out the help of a financial professional before making any investing or personal financial management decisions. The education contained in this article may not be suitable for everyone — use it at your own risk.