Trading is seductively simple, but markets are deceptively complex. – Jani Ziedins (via Alpha Trends)
The above quote is appropriate in discussing so-called investing contests that are often pitched to school age children. Jason Zweig in a WSJ piece looks at the lengths to which some contestants in this contest will go to win. This often involves leveraging their hypothetical portfolios, taking highly concentrated positions and using leveraged ETFs. In short, Zweig asks whether kids are learning the wrong lessons from these contests.
A couple of quotes from teachers using these contests in their classrooms highlight the paradox:
“Nobody’s going to win the Stock Market Game picking big safe stocks everybody’s heard of,” says Jay Watts, a teacher at the Westminster Schools in Atlanta…
“The way to win this competition is to break every rule of sound investing that I just taught you.” – Roger Shaffer
In this contest there is no downside to taking on incremental risk. In a prior post we talked about how “fantasy stock picking” contests that teach investors some bad lessons. In that sense stock picking contests are not unlike paper trading. There are some legitimate uses for stock market contests and paper trading. Both provide beginning investors with some experience in the mechanics of trading and investing. New traders would do well to keep in mind these rules for novice traders.
What they don’t do is provide a tangible connection between risk and return. Once you put dollar one on the line your reaction to drawdowns changes dramatically. There is no way in which stock picking contests or paper trading can do that. That is also one of the challenges of backtests. Any more it is deceptively easy to do a backtest on any number of trading strategies. We get hypothetical return charts but what can’t get is the feeling that one would have had in real-time following that strategy. A long time ago we wrote:
Back-testing is in the end a tool, nothing more, nothing less. It can provide insight into how the markets operated in the past, but the future may be very different. The best use of back-testing software is as a risk-management tool. While the best entry/exit methods may shift over time, prudent risk management techniques never go out of style.
That is not to say that stock picking contests can’t be designed for better results. David Merkel at Aleph Blog has a list of ten rules that should be followed when putting together a stock picking contest. Forced diversification, no leverage and size constraints would all help reduce the speculative behavior that now characterizes the winning participants. Now getting some organization to underwrite a more realistic contest is the real challenge.