(MONEY Magazine) -- Question: I have a budget of $10,000 for a stock simulation I'm doing for a business and personal-finance class. What stocks should I invest in to make the most money in four months? -- Matt
Answer: I hope for the sake of you and your fellow students that this simulation represents some sort of academic exercise as opposed to your instructor's views on the right way to invest in the stock market.
As I've noted before, investing is more like a marathon than a sprint. So I don't believe that performance over a few months -- or even a few years -- is a very good gauge of one's prowess as an investor or stock picker.
I also think that focusing on such a short time period could make it more difficult to cultivate the patience you need to succeed as an investor.
But with those caveats in mind -- and assuming the $10,000 you're investing is theoretical money as opposed to real bucks -- I'm going to tell you what you should do to give yourself the best shot at making the most money within four months and beating your classmates in this exercise.
Actually, the advice I'm about to give is based on the experience of Moshe Milevsky, a finance professor at York University in Toronto. In addition to being an expert on risk management, an authority on retirement planning and a very entertaining speaker, Milevsky won the annual stock-picking contest run by Canada's Globe and Mail newspaper three years in a row earlier this decade.
The Globe's contest is a bit different than your simulation contestants pick only one stock and they're judged on their return over the course of a year as opposed to four months. But there's enough similarity that Milevsky's approach should be applicable.
So what, exactly, was his strategy?
He purposely avoided solid companies that could generate reliable gains over many years. Instead, he looked for stocks of companies that had the potential to zoom to outsize short-term gains and that would be less likely to follow the rest of the stock market (which means they'd be more likely to separate themselves from the picks of other contestants).
Specifically, Milevsky looked for stocks that had huge swings in their prices, as measured by standard deviation, and that were more likely to zig when other stocks zag. "The secret to winning -- if there is any secret -- is to pick a stock that is highly volatile and negatively correlated to the rest of the pack," according to Milevsky and a colleague in a technical paper.
And, in fact, Milevsky won the contest in 2004 with a stock featuring a 117.3% return. Canadian Superior Energy, a tiny oil and gas exploration and production company based in Calgary, had the qualities he was looking for in spades. It had a standard deviation of 102%, which makes it roughly five times as volatile as the Standard & Poor's 500 index, and it had a negative beta, which means it would be expected to move in the opposite direction of the market.
So if you want to apply Milevsky's strategy to your simulation, you should look for stocks with highly volatile share prices that don't march to the same tune as the market.
I don't know what stock-picking tools your school makes available to you. Ideally, you'd want to be able to sort stocks by a variety of factors, including standard deviation, correlation, beta and past returns. But if you don't have access to a database and screening tool, you should be able to come up with a reasonable list of candidates by going to a site like RiskGrades, which allows you to screen for volatile stocks, and by revving up Google's Stock Screener, which allows you to specify beta as a criterion. (Just click on "Add Criteria," then "Stock metrics," then "Beta."
I don't know how many stocks you're required to buy in your simulation. But if your goal is to shoot for the highest possible return, you'll want to buy as few as possible. Why? Well, although diversifying is normally a good strategy for reducing risk, remember: in looking for the highest possible short-term return, you're standing conventional investing strategy on its head. So in this case, you don't want to diversify as doing so dilutes the effect of any big winners.
Now for the caveats. Even if you follow Milevsky's strategy, success is hardly assured. Far from it. In a technical appendix to his paper, he shows why the probability of winning using his system comes close to but can never exceed 50%. The best you can hope for is a near 50-50 shot at success.
And in those instances where you don't win, there's a good chance that the high volatility and low correlation may work against you. In other words, instead of racking up big gains, you may incur stomach-churning losses. Which is why Milevsky specifically warns that anyone "who attempts to replicate or mimic the behavior of the so-called contest winners with real money is likely to be disappointed."
Indeed, professor Milevsky and his co-author make it clear that they are in no way are they recommending that individuals adopt the techniques outlined in their paper as a an investing strategy: "Our main intellectual objective...is to illustrate the critical difference between a rational and prudent strategy for building wealth versus the optimal strategy for picking stocks in these all-or-nothing contests."
So if you want a better shot at beating your classmates in this exercise -- while recognizing that you may also end up bringing up the rear -- then you may want to give Milevsky's strategy a try.
But when you're looking to invest $10,000 of your own money in stocks, I suggest you simply plow the ten grand into a low-cost total stock market index fund or ETF like the ones listed on our MONEY 70. You may not have the highest return after four months, but you'll likely do better than most investors over the long haul.
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