Well played, Vegas. Well. Played.

My first and only Las Vegas trip was over 20 years ago. I was, in the words of Khalid, “young, dumb, and broke.” Literally. I was young, a college drop-out, and had maxed out all of my existing credit cards… except my new Discover card with a $500 limit, which was burning a hole in my pocket. My friends and I loaded up a Jeep Cherokee and set out from Ohio to explore the once wild west.

I still remember the feeling of walking into the Bellagio Hotel & Casino—I was taken in by the immediate luxury of the entrance, the enticing presentation of the games, and the eager patrons living the high life. I knew I couldn’t gamble without sacrificing the money I needed to make the trip back home—but I had played my fair share of poker and felt confident that I could beat the odds. Well, I’m not the first or last young man taken down by hubris. Vegas quickly took what little money I had.

Soon I was young, dumb, broke…and starving. I suggested we take advantage of an all you can eat buffet, but my friends convinced me to pass on lunch and purchase tickets to an expensive evening show that was advertised to include a steak dinner. That seemed to give more for our money, so it seemed foolish to pass it up.

When we arrived at the show, I noticed that there were no tables, just theater style seating. I asked my friend if he was positive that we paid for a steak dinner, and he showed me the line at the bottom of the receipt listing a sizeable dollar amount (to me, at the time) after the letters “STX.” I marched out front, “Yo, where is my steak dinner??”, pointing to the STX line on the receipt. I was politely informed that STX stands for state tax. If you could feast on humiliation, I would have been full for days.

“You don't know when to quit, do ya Griswold? Here's an idea, why don't you give me half the money you were gonna bet, then we'll go out back, I'll kick you in the nuts, and we'll call it a day!” – Marty (Vegas Vacation)

Stepping into the financial markets is no different than walking into the Bellagio casino with its various games. Each game has different rules, highly skilled players, and always an edge tilted in favor of the house (your broker) and/or the pros across the table. The casino’s poker, blackjack, roulette, craps, and slots are akin to the market games of day trading, options, currencies, futures, and on and on and on. Still feeling lucky?

The financial markets are like Vegas – they want to take your money, including your safety amount for the trip home. Big fish or small, they want it all. The professionals, with their high frequency black boxes, are bigger, smarter, and faster than you. Institutional traders are backed by quantitative geniuses hailing from MIT to feed their emotionless algorithms through higher-speed fiber optic cables. To what end?

Taking every last penny you own.

In the pros’ defense, discretionary active managers do play an important role in the markets by facilitating price discovery (which I’ll discuss down the road). However, their benefit to the market is not altruistic—there is no steak dinner coming your way!

What about zero trading fees, you ask? Just the carrot they use to incentivize you, the product, to keep playing. Similar to the free cocktails that keep showing up at your blackjack table. Brokers sell order flows to the highest bidder – allowing them to front run your order, scalping fractions of a penny per share. Doesn’t sound like much, right? Well consider that, according to the Financial Times, “In the year to June 2021, Citadel Securities paid nearly $1.5bn to brokers for their order flow, according to regulatory filings collated by Bloomberg Intelligence, the most of any market maker.” Citadel’s returns on order flow purchases are unclear, but it’s safe to assume it is several multiples beyond their $1.5bn investment. And Citadel is just one example.

If 20 years ago, I told my father I wanted to be a neurosurgeon, he would have supported that decision. A successful immigrant from India, he always believed that I could accomplish anything through hard work. However, if I told him I want to actively trade my own account, he would have slapped the stupid out of me. The reason being, before a neurosurgeon cuts into a human head, they’ve undergone years of intense education and practice with the support of teaching professionals. The underperforming students are weeded out along the way. The bar, however, for cutting into the financial market is low—all you need to put your financial future under the knife is a pulse and some cash.

Over half of finance students who sit for the Chartered Financial Analyst (CFA) Level 1 exam fail each year.

Several articles, including this one from Market Insiders, point to the failures of retail traders:

• One study of Brazilian futures traders found 97% of day traders lost money over a period of 300 days.

• Another study of day traders in Taiwan between 1995 and 2006 found only 5% of day traders to be profitable.

• A study by the U.S. Securities and Exchange Commission of forex traders found 70% of traders lose money every quarter on average, and traders typically lose 100% of their money within 12 months.

• A study of eToro day traders found nearly 80% of them had lost money over a 12-month period, and the median loss was 36%. Read the full article here.

Joel Greenblatt, CO-CIO of the successful Gotham Funds and adjunct professor for MBA students at Columbia University, has frequently said, “Warren Buffett says most people should index, and I agree with him. But Warren Buffett doesn’t index, and neither do I.” Indexing requires putting your money into a fund that tracks the overall market (mainly the S&P 500) and leaving it there for a very long time. This ensures you make beta each year, or track the return of the overall market, avoiding both underperformance and overperformance (alpha). In an interview with the Wall Street Journal, Greenblatt further explains:

“When people can check their returns 30 times a minute on the internet, time horizons shrink, investors are impatient and sell at any sign of underperformance, so they fail to participate in periods of over performance.”

In several interviews, Greenblatt explains posing the following question to his Columbia MBA students, "How do you beat Tiger Woods?” The answer, “Don't play golf." In other words, you NEED an edge if you want to go head-to-head with the pros. Don’t play their game by their rules.

 So, can retail traders succeed? Yes, but it requires willingness to put in the necessary work to be fully educated on the game, understand the opponent and their edge, develop a better edge, and properly manage risk (and emotions).

Unwilling to do all of the above? Then yeah, just index.

“Because the house always wins. Play long enough, you never change the stakes, the house takes you. Unless, when that perfect hand comes along, you bet big, and then you take the house.” – Danny Ocean (Ocean’s 11)

Thank you for reading! I hope you enjoyed this post and found it educational. Feel free to subscribe and catch my next post in which I’ll explain why I trade big themes, have a 3–5-year time horizon, and consider how liquidity is relative and can be advantageous to small investors.

In future posts, I plan to begin breaking down the financial ecosystem, tools for financial analysis, understanding risk and volatility, how to value a business, managing emotions, and so much more. If you’re curious about topics I haven’t mentioned and have a request for a future post, drop me a line!

Today’s recommended readings:

The Big Secret for the Small Investor: A New Route to Long-Term Investment Success by Joel Greenblatt

Market Wizards: Interviews with Top Traders by Jack Schwager

Today’s recommended podcast:

Episode 78. Chat With Traders: Jack Schwager – The Making of Market Wizards, and Wisdom From Elite Traders

And as always, swim with caution!

@EdgyFin on Twitter

Disclaimer: EdgyFin is for educational purposes only and should not be considered investment advice. Please do your own due diligence and consult with a professional before you risk it for the biscuit!