Stacking the deck

August 19, 2015 01:00 PM

What separates investing in stocks from gambling on them? Taking advantage of hot stock tips from brokers or blog posts, jumping into bull and bear markets and day trading make the line pretty blurry at times. Some consider a longer-term view based on fundamentals the difference, à la Warren Buffet or Benjamin Graham. However, there is plenty of speculation in fundamental investing as well: When will the Fed raise rates?  Will lumber prices continue to rise?  Will growth in demand for tablet computers continue to increase at its current rate?

The major difference is knowing the odds and acting when you perceive an edge. While professional gamblers certainly understand odds, recreational gamblers continue to go to casinos even though they know that the odds are stacked against them because of the thrill and hope of “going on a heater.” 

Investors, however, do everything they can to get the odds in their favor. Fundamental investors use forecasting product revenues, market growth, competitive differentiation, strength of management, etc., to make the best bets. Technical traders and quants rely on reading charts, constantly adjusting models and looking at new factors that might get them up from a 53% to a 54% hit rate on their trading models.

What complicates this is that the price of securities is driven by investors with a host of different biases, timeframes and levels of rationality. For example, look at Chinese stocks this summer. The Shanghai Composite Index ran up an amazing 150% in less than a year through mid-June, then in early July it gave up more than 20% in two weeks. Sound like euphoria on the way up and fear on the way down? 

How can you use this information to get the odds in your favor? By quantifying the information in price trends.

EidoSearch applies a new, patented method for prediction to quantify the value of information in numeric data patterns including price. Think of us as Google for numeric search. Give us a sample price pattern, say the last year trading in Facebook, and we find the most similar instances in history to see how investors have reacted to these conditions. Many times the reaction is no different than the average return or volatility for a stock, but many times it is distinct. The statistics in the data inform us about the probable future responses by market participants and provide an edge for investors.

How do you find the outliers?  We look through 100 billion patterns in about a minute, allowing us to look at thousands of different securities every day to isolate patterns that carry a statistical edge.

Because we’re talking about speculation and odds, we took a look at a few of the bigger gaming and casino stocks: MGM Resorts (MGM), Las Vegas Sands (LVS), Wynn Resorts (WYNN) and Melco Crown Entertainment (MPEL). The group had been beaten up in the first half of the year, but then got a nice bump in early July on the easing of tourist restrictions in Macau. 

We looked at the six-month price patterns of each, and searched through millions of patterns in gaming and casino stocks historically to find the most similar instances and to see how investors are likely to react today and projected out to Oct. 1 (see “Picking winners,” below).

 

As a group the rebound typically doesn’t last long, although a couple of the stocks have done a bit better in these circumstances. The pattern for MGM (see “Profitable pattern,” below) during the past six months is a bit more unique so there are not as many matches (statistical significance), but similar instances historically have been up 71.4% of the time and the average return of all 21 matches is 7.0%.

About the Author

Dr. Steven Zhang is the CEO at EidoSearch.com, a  Ph.D. in electronic engineering and an internationally renowned expert in information processing technologies. His expertise is in the areas of signal processing, multimedia content analysis, computational intelligence, pattern classification, as well as, applications in bioinformatics and finance. 
@EidoSearch