How to Win CNBC's Million-Dollar Portfolio Challenge

Last year, right before its annual contest started, I wrote an article about how to win CNBC's 2007 Million-Dollar Portfolio Challenge. Now that the fantasy stock-picking game is back (following some retooling because of possible cheating by a number of Class of '07 participants), I thought I'd revisit the concept of how to win it -- and the $500,000 which goes to the winner.

Get ready to get smarter
The first thing to keep in mind at all times is that this is not a contest to identify or test investing acumen. Superior investing returns are properly measured over years, and are achieved by taking an appropriate level of risk.

A two-month long contest that rewards only the very top performer each week out of a crowd of what will be hundreds of thousands of participants (each of whom may enter five separate portfolios), is not testing your abilities or intelligence as an investor. To come out on top of a very large group of competitors measured over such a short time period is simply a matter of luck.

That said, the best way to put yourself in the way of the good luck necessary to win the contest is to take the absolute greatest amount of risk that the contest allows. In other words, simply increase the randomness and volatility of your results. To do less, is to simply acknowledge that you're not in the contest to win.

It works
The 2006 contest was won by somebody who put all of his notional money into one company. This company also happened to be embroiled in a Ponzi scheme investigation at the time, and is today essentially worthless.

Now, to take a million dollars and put it into one stock that is quite likely a fraud is the epitome of recklessness and stupidity in real life. But to play that move in a game, in the hopes that a severely beaten-down stock will catch a few moments of glory off of "a dead cat bounce," is brilliance.

And so, as long as you accept that what makes sense in this game is often the polar opposite of what you should do with actual money, there's fun and, for a very few people, rewards, to be had. So here's how you should proceed:

1. Use all five portfolios. This one is obvious. You can't win if you don't play, and you can't maximize your chances of winning if you don't use all the portfolios available.
2. Maintain a super-concentrated portfolio. In this year's contest, you can no longer place all of your notional million into one stock; you can put only 25% of your portfolio into any one position in the 2008 version of the game. Playing as close as you can to the minimum of four stocks maximizes the randomness and volatility of your results.  
3. Size matters, so go small. Small caps generally move more dramatically than large caps whether there is news or not. Unfortunately, you can't play with micro caps since the contest is limited to companies that have market caps of $500 million or more, but the closer you play to that cutoff line, the better your chances of putting a dramatic move in your portfolio.
4. Focus on earnings announcements. You also maximize your chances of getting a big move if you focus on stocks with earnings announcements scheduled during the dates that the contest is live. While small companies are your best bet to get volatility playing the earnings game, even Google (Nasdaq: GOOG) managed a 20% jump on the release of its most recent earnings, thanks to its beating expectations.
5. Look at companies trading at or near 52-week lows. That's where Google was prior to its earnings announcement. The announcement was certainly good, but the magnitude of its move was made possible by being so beaten down.
6. Celebrate low-priced stocks. Speaking of beaten down, stocks trading below $10 or even $5 per share are more likely to make extreme short-term moves than companies of similar market caps with higher per-share prices. That's a market anomaly, but an enduring one.
7. Look for shorts. Stocks with a large chunk of their shares shorted are great candidates for quick upward moves, especially when combined with the potential for a good earnings announcement. When there's a significant portion of the stock shorted and the stock starts to move up, the shorts start to cover and send the stock even higher.
8. Merger mania. Investing real money solely on the possibility of a merger or acquisition is loony. But for this contest, it makes sense. Microsoft (Nasdaq: MSFT) may or may not really have walked away from Yahoo! (Nasdaq: YHOO), but in the absence of a better idea, or until a better idea comes along, it makes some sense to play Yahoo! for a quick pop on the hint or rumor that merger talks could reawaken.
9. Biotechs, baby. Biotech stocks frequently populate both the top performers of the day and the top drops of the day as major news is released about a drug trial. As for which biotechs will have trial results forthcoming, I pinged our biotech guru Charly Travers. Myriad Genetics (Nasdaq: MYGN), he told me, "is releasing phase 3 data on its drug Flurizan for the treatment of Alzheimer's disease in June." Now, Charly -- like most of the investment community -- doesn't expect the results to be positive. But since expectations are so low, we could see a pretty big pop if the announcement contains any good news at all.
10. Simply have fun. Having spoken with the fine people at CNBC about their contest, they fully recognize that they're offering a fun game -- not a real exercise of their contestants' investing acumen. Remember that and enjoy the opportunity to trade stocks in a way that you would never attempt in real life.

Some additional ideas
Combining some of these criteria, here are a few small caps with low share prices, high short ratios, and upcoming earnings:

Furthermore, Blockbuster and Circuit City offer the added volatility of a bizarre merger contest that involves angry activist shareholders.

Back to reality
It behooves me to point out, once again, that I don't consider employing most of these tactics a worthwhile way to invest. Yes, small caps provide better returns than large caps over the long term, and we explore how to actually invest in them in a real-world sense in Motley Fool Hidden Gems. In fact, you can see our top small-cap picks for new real money now, by clicking here to join the service free for 30 days.

But life isn't all about real-world achievable returns, nice as they are. Sometimes, it's worth seeing whether you can turn $1,000,000 into $3,000,000 in a matter of weeks, especially when there's nothing to lose by trying.

Bill Barker does not own any stocks mentioned in this article. Microsoft is a Motley Fool Inside Value recommendation. Myriad Genetics is a Rule Breakers pick. The Fool has a million-dollar disclosure policy.