The Buying Game

There is great article, by Rob Walker, in the New York Times Magazine section, entitled "The Buying Game" - A Real Market, Overseen by a Real Corporation, Selling Things that Don't Really Exist.

The article was about an online computer game called EverQuest that has spawned a real money marketplace. I am pretty certain that the behavior of individuals in what is acknowledged to be a completely imaginary game, can probably teach us alot about investing in our own financial markets. Interestingly, if you substitute "stock market" for "Norrath" (the name of the virtual world in EverQuest) in the article, you come away with a pretty good description of the stock market.

For instance, "Althought the goods are digital, it's not quite right to say they don't have real value; pretty much from the earliest days of Norrath, Castronova discovered, game players found ways to pay real-world dollars for fake-world things."

Edward Castronova, will in fact be coming out with a book soon, entitled, "Synthetic Worlds", that looks at the economics of these imaginary games. He points out that, "Most of the popular games have always built-in (fake) currencies and thus marketplaces."

So what can we learn from these acknowledged imaginary games? Well  we'll have to wait for Castronova's book, but in the meantime, I think it safe to say that if you truly buy the notion that the stock market is merely a game created to facilitate the exhange of paper, which has no real intrinsic value, there are some important lessons.

My main conclusion is that you can never really buy a stock or justify holding one, solely based on standard valuation considerations, because there really is no value here. It's merely a game of musical chairs, as Keynes liked to point out. As Rob Walker writes, when talking about imaginary games, "How much of the difference is "real" and how much is essentially in the mind?"

The important thing, then, is to try to understand the psychology of the players in the stock market and what would prompt them to buy or sell a particular stock. In other words, it is all about emotional sentiment. When sentiment changes to the negative, no amout of number crunching can support a stock price, and conversely, when it turns positive, no amount of valuation measures can limit the upside.

It is of course very difficult to ascertain a sentiment change (i.e. Has the sentiment changed for oil prices? If so, there will be alot of downside destruction in energy stocks...), but that always needs to be the basic idea behind any investment analysis. The trick as always is to be able to buy stocks when the sentiment is still negative, but there is some evidence that sentiment will change in the future due to changes in the underlying business.

More importantly, it is vital to focus on long-term business trends, so as to avoid becoming prey to the periodic bouts of panic selling that can make you into think there is a sentiment change, when in reality there is not. If the long-term qualitative business factors are still strong, there cannot be a true sentiment change.