Why It’s Hard to Pick Stocks

A friend (who works in a field as far removed from finance as a field can be) recently asked me why I do not invest in individual stocks. Rather than trying my normal direct explanation, I replied with the following analogy. It’s not perfect, but I think it got the point across. Hopefully you’ll find it entertaining or useful.

Imagine that a friend asks you to go with him to an antique show/fair that’s going to be in town this weekend. It’s a decent-sized one. There’s going to be several thousand items for sale.

You’re not particularly interested in acquiring anything for your own use. But you decide to go along, hoping that you can find a “deal” — something that’s significantly underpriced, which you can sell on eBay for considerably more than you’ve paid for it.

What’s going to affect your likelihood of finding such a deal?

Here are a few factors that I can think of:

• How early you arrive.
• How many other shoppers there are.
• How well informed the other shoppers are.
• Whether you have any relevant expertise (e.g., if you have an encyclopedic knowledge of rare coins, that could be helpful).

You arrive at the market as soon as it opens, Saturday morning.

But you promptly learn that your friend misread the advertisement. The show opened yesterday. Thousands of shoppers — including many experienced antique bargain hunters — have already been through, picking over all the items.

In fact you learn from another shopper that many of the vendors themselves shopped around at other booths, buying items they thought were underpriced, and then putting them back up for sale at their own booths, at higher prices that they considered more appropriate.

How optimistic are you at this point that you’re likely to find a bargain worth buying?

Not very, probably.

That’s the stock market. Except in the case of the stock market, the market has already been open for many years. There are literally millions of other shoppers. Thousands of professional bargain hunters, shopping every day. And there’s a good chance that you have no particularly relevant expertise.