Back in my freshman year of high school, I embarked on an unusual journey. I had no way of knowing it at the time, but it was one that would forever change my life.
There were lots of special journeys that year: playing high-school football, parent-free parties, sneaking out of my basement at 1 a.m., etc. But it was my pre-calculus stock market simulation -- of all things -- that would ultimately teach me three simple rules about the world and the stock market.
The stock simulation
Every day in math class, I sat next to an unusual kid named George. This was a guy who appeared to have it all figured out. Despite his dogged insistence that we ditch history class to either water-balloon kids at our rival school, or loiter around in the lobby of the all-girls' school next door, George was definitely a smart cookie.
What made George special was not his high GPA. It was that he had this ability to intuitively know things about subjects that none of us at that age had ever encountered before. He just understood things, and this made his presence extremely useful to the rest of us around him.
Anyway, George and I started this stock market simulation with a group of kids all eager to succeed (things get pretty competitive in all-boys schools). I had my strategy well-designed. I furiously read every article I could from The Wall Street Journal, Financial Times, and The Economist. Then, I'd buy traditional, big-headline companies like Ford and Exxon-Mobil based on the advice of authors or analysts who advocated purchases of the stock.
I brought newspapers to school every morning after my Dad was finished reading them. I brushed up on my knowledge before class every day. I was doing everything I was "supposed" to do, and I thought I was going to be the next Gordon Gekko.
What the heck?
A semester of this went by, and guess what? I was getting crushed.
I recall sitting in the third-to-last position in a class of about 17. My returns were garbage -- well in the red -- and far behind the returns of classmates who were literally doing nothing and just picking random tickers.
George, meanwhile, was off the charts. He was way off in first place. The guy didn't read a lot, didn't spend any extra time researching. What the hell was he doing? Was he cheating? Did he hack into the software somehow?
It took me a while to swallow my pride and ask him why his strategy was so much better than mine, but I did, eventually. His response:
Kapur, I just do the exact opposite of what you do.
Not what I wanted to hear
What? How can someone do the opposite of what every newspaper and analyst in the world told me to do and still win? How is that possible?
Well, it was in George's ability to be unlike everyone else that he found a way to thrash the market. It was brilliant.
George broke it down to me like this: Every time the media or the market would hammer a stock that he liked, he would step in and buy. Every time the media or the market started to put a premium on a stock he didn't really feel confident in, he'd short-sell it. He'd buy what went down and short what went up. That's it.
Of course, making money in the stock market is slightly more complex than this alone. But imagine yourself having this kind of mentality in today's market. It would require the type of disposition that would allow you step in and short Apple (Nasdaq: AAPL ) at all-time highs, while it churns out billions in free cash flow, pushes extraordinary growth expectations, and is the darling of media and public alike. It would require the self-confidence to step in to buy a cheap stock like Biglari Holdings (NYSE: BH ) , owner of Steak and Shake, a company that had been perpetually ignored by the Street and a restaurant that was a consumer favorite perhaps in the '50s. It would ask that you buy Southwest Airlines (NYSE: LUV ) in the middle of a terrible consumer environment and rising oil prices, knowing full well how difficult it is for airlines to make money in this country. In other words, replicating such a strategy requires the individual to look at the world completely differently than everyone one else does.
The three rules
George had literally decided to do the opposite of what I was doing at the time and was crushing everyone in the class at the same time. In his explanation as to why, he revealed to me three simple rules that have since changed my life:
- Ignore everyone's (especially the media's) stock-specific advice.
- Do the exact opposite of what you expect everyone else will do.
- Feel comfortable being the only person doing what you're doing.
How he knew these things, I have no idea. But they began to make a whole lot of sense several years later, once I developed an appreciation for how the market really functioned.
This was incredibly prescient advice coming from a 13-year-old kid who'd rather spend his time water-ballooning fellow students than burying his nose in an analyst report. Many years later, I realized that these were the hallmarks of some of the world's most famous investors. Names like Buffett, Templeton, Graham, and Soros sound familiar here, yet this advice was being shared between two kids who couldn't even get into an R-rated movie.
These days, it's good to challenge some of our most fundamental and most popular assumptions about the market. We might assume that with Democrats in the White House and Congress, health-care operators like UnitedHealth (NYSE: UNH ) will be stifled. But the fact is, the market has already priced in much of this logic, and because of this, UnitedHealth and others in the industry look reasonably cheap. The company's economic capacity will eventually push through this larger fog of negativity, and shareholders willing to look past present-day collectivist thinking should be rewarded.
Similarly, shareholders might be terrified to step in and buy shares of Goldman Sachs (NYSE: GS ) right now with all the heat the company is taking. But, the overwhelming likelihood is that Goldman will figure out a way to make money regardless of the regulatory punishment they take.
It all makes sense
To complete the story, let me say that following high school, George went off to Harvard, where he co-authored a book on behavioral finance at the tender age of 22. After that, he helped run a prop-trading desk at a major investment bank, and today he's finishing up an advanced degree at yet another Ivy League institution. Needless to say, when it comes to the stock market, George is working at an advanced level.
Unfortunately, there are many investors who don't see the beauty of a system that asks you to go against the conventional wisdom of the masses. Why? Mostly because it's uncomfortable and it's difficult -- even unnatural -- to do the opposite of what everyone around you is doing. But, as George discovered at an early age, the stock market is not a popularity contest; it's a mechanism for building wealth. Thus, his strategy has some serious merit.
The Foolish bottom line
If you follow the rules set forth by my precocious classmate and begin to push against the grain, you're likely to develop serious market-beating talent.
Because of this, I encourage you to take a look at the Motley Fool Inside Value service, where advisor Philip Durell seeks to unlock the value within stocks that the masses have tossed aside. The strategy works, it's yours to examine free for 30 days, and it's one of the surest paths to a market-beating portfolio. Click here to see for yourself.
This article was originally published on October 24, 2009. It has been updated.
Fool Nick Kapur has no positions in any stock mentioned above. He also suspects he's slowly becoming a better investor than George. Ford, Apple, and UnitedHealth are Motley Fool Stock Advisor recommendation. The Motley Fool owns shares of UnitedHealth and has a disclosure policy.