August is one of my favorite times of the year. I like to spend most of the month at my vacation house, which overlooks Lake George, N.Y. From there, it's easy to get to the horse races on the beautiful old thoroughbred race track in Saratoga.
I have been an avid horse racing fan since high school and have been going to the Saratoga track since 1981. I even appeared in "
," an original painting by Anthony Alonso, which also appeared on the Saratoga visitor's guide a few years ago.
In that time, I have been very successful at winning money at the races, even though I'm not a big bettor. For me, going to the races is a form of entertainment, not income generation. Nevertheless, there are many lessons I've learned at the race track that are also applicable to trading and investing. Here are five.
1. Don't Bet Every Race
A typical horse racing card has 10 races. The most exciting minute-and-a-half in sports is a thoroughbred horse race. However, the wait between races can be as much as 30 minutes. There is a tremendous temptation for bored bettors to place a wager on every single race. This is a mistake. Not every race is worth betting on. Some may be too hard to pick, while others may have a high risk/reward profile. The same can be said for trading and investing.
There is a temptation to want to trade each and every day. Sometimes the best trade is the trade
made. Disciplined traders and investors will wait for a buy or sell price level to materialize before making a move. This could take days or weeks, so you need to be patient and selective.
2. Do Your Research
Picking a horse to come "in the money" -- "win" (first place), "place" (second place) or "show" (third place) -- is no easy task. There are many variables that come into play in determining which horse to bet on. These include, but are not limited to, past performances, Beyer Speed ratings, track conditions, the jockey, the trainer, bloodlines ("sire" is the father and "dam" is the mother), length of the race, post position and surface type (dirt, synthetic, grass turf). It is pure folly to bet on a horse based on name, number or jockey silk colors, though many people do. You need to do your research. This means that, as a bettor, you must read the
, the horse racing equivalent of
The same diligent approach is necessary for stock investing. We would not invest in a company solely based on its logo or company symbol. Think of it: If your name was Joe, would you invest blindly in
St. Joe Co.
? If your favorite color was blue, would you invest in
, which is known as Big Blue? Of course not. As I have emphasized in the past, in order to make an informed investment, you have to read company financial statements and listen to earnings conference calls.
3. Eliminate the Losers
Picking winners is not an easy task. However, if you can eliminate the losers, then you are left with a pool of more likely winners. It is like taking the SAT or any another multiple-choice exam. First, you have four possible answers. You eliminate two answers that are definitely wrong. Now, you have increased your percentage of success from 25% to 50%. At the race track, the process is the same. I begin to evaluate a race by crossing out those horses with no chance of winning. You can do the same with investing.
Let's say you want to use the
. Your objective is to outperform that index. You can do this with a "bottom-up" approach, which is to start with a clean slate portfolio and then build a portfolio that you believe will outperform that benchmark. However, another way to achieve this goal is to start with the entire S&P 500 as your portfolio and eliminate those stocks or sectors that would underperform the index. If you eliminate the underperformers, then you will be left with a portfolio that outperforms. For example, had you eliminated autos, retailers and financials from your investment universe and kept all other S&P 500 sectors in your portfolio, you would have had a leg up on outperforming the index.
4. Not All Favorites Are Good Favorites
Each horse is differentiated by an odds system. For example, a 2-to-1 horse is expected to win by more bettors than a 5-to-1 horse. However, bettors are not always correct. Just because a horse has the lowest odds in the race -- making it the favorite "chalk" -- does not mean that it will necessarily win the race. So a great way to win at the track is to eliminate "bad favorites." These are horses that the crowd thinks will win but which your research indicates may not. Thus, you look for better value with a stronger candidate and at a higher price (odds). The same bad favorite concept exists in investing. It's called the "value trap."
Take a stock like
, for example. People think that Pfizer is a solid company in a very stable industry (pharmaceuticals). The stock's dividend yield of 6.70% makes it look much more attractive than other companies in more volatile industries, and that don't pay a dividend -- take
Research In Motion
( RIMM) for example. Pfizer may look like the best bet out there, but the 6.70% dividend is not enough to replace the lost share price value. I would categorize Pfizer as a bad favorite. Still, investors will "play it" anyway. Between Pfizer and Research In Motion, I would put my money on Research In Motion.
5. Be Aware of Derivatives
Horse racing has its share of exotic bets. These include the Daily Double (picking the winner in two consecutive races), Pick 3 (picking the winner in three consecutive races), Pick 6 (picking the winner in six consecutive winners), Exacta (picking the horses in order to win and place) and Trifecta (picking the horses in order to win, place and show). These types of bets are far more complex than just picking a single horse in a race. Additionally, the cost of these bets may be greater than a single win bet if you "box" (select several horses in all combination and permutations) or "wheel" (key-in one horse and then combine it with others). However, the payouts in these exotic bets can be enormous. My friends and I invested $2,000 in a Pick 6 in 2001 that returned $106,500, including "consolation" tickets. Not bad for a day at the track.
In the investing world we have our own version of exotic investments. These are called derivatives. Derivatives come in many forms such as options (via "calls" and "puts"), swaps, convertible securities and futures. All of those securities have risk profiles which could return much greater payouts than just owning an individual stock. However, the cost and risk are also greater.
Betting exotics at the race track or derivatives in the financial markets is not for the unsophisticated participant. However, the rewards are far great, so with careful study and experience you can include these investments in your portfolio.
As you can see, there are many ways in which skills developed at the race track can be applied to trading or investing. Here are some suggestions for developing those skills:
Spend a day at the track. I would suggest the more popular tracks such as Belmont, Saratoga, Arlington, Monmouth, Del Mar or Churchill Downs. At the track, observe (without betting) how odds are made, how bets are made, how bettors place exotic bets and the race itself. Then see the payouts to winners after the race is over. Pick up a copy of the Daily Racing Form or the local track program (with past performances) and use that to simulate some bets.
Read and then reread Picking Winners by Andy Beyer. This is the horse racing equivalent to Benjamin Graham's Security Analysis.
Look at your portfolio. Do you have any bad favorites? Should you eliminate perpetual losers?
At the time of publication, Rothbort was long RIMM, although positions can change at any time.
Scott Rothbort has over 20 years of experience in the financial services industry. In 2002, Rothbort founded LakeView Asset Management, LLC, a registered investment advisor based in Millburn, N.J., which offers customized individually managed separate accounts, including proprietary long/short strategies to its high net worth clientele.
Immediately prior to that, Rothbort worked at Merrill Lynch for 10 years, where he was instrumental in building the global equity derivative business and managed the global equity swap business from its inception. Rothbort previously held international assignments in Tokyo, Hong Kong and London while working for Morgan Stanley and County NatWest Securities.
Rothbort holds an MBA in finance and international business from the Stern School of Business of New York University and a BS in economics and accounting from the Wharton School of Business of the University of Pennsylvania. He is a Term Professor of Finance and the Chief Market Strategist for the Stillman School of Business of Seton Hall University.
For more information about Scott Rothbort and LakeView Asset Management, LLC, visit the company's Web site at
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