Investing Advice: Why Winners Keep Winning

Posted On May 18, 2018 1:42 pm

Over the past few years, so much of the narrative has been winners keep winning in a self-perpetuating trend. Today’s investing advice will explain the math behind this pattern.

The notions of scale, network effect and moats have all been great themes for investors to latch to for big gains.  But the cost seems to be a crushing of competition, the move to passive investing which leads to large capitalization stocks to become mega-monopolistic companies and ultimately causes the growing societal crisis of income equality.

Nick Maggiullli has a thoughtful piece explaining Why Winners Keep Winning

The late 1970s the view in the publishing world was that an author should never produce more than one book a year. The thinking was that publishing more than one book a year would dilute the brand name of the author. However, this was a bit of a problem for Stephen King, who was writing books at a rate of two per year. Instead of slowing down, King decided to publish his additional works under the pen name of Richard Bachman.

Over the next few years, every book King published sold millions, while Richard Bachman remained relatively unknown. King was a legend. Bachman a nobody. However, this all changed when a book store clerk in Washington, D.C. named Steve Brown noticed the similarity of writing styles between King and Bachman. After being confronted with the evidence, King confessed and agreed to an interview with Brown a few weeks later. The Click Moment: Seizing Opportunity in an Unpredictable World tells the story of what happened next:

In 1986, once the secret was out, King re-released all of Bachman’s published works under his real name and they skyrocketed up bestseller lists. The first run of Thinner had sold 28,000 copiesthe most of any Bachman book and above average for an author. The moment it became known that Richard Bachman was Stephen King, however, the Bachman books took off with sales quickly reaching 3 million copies.

This phenomenon isn’t exclusive to Stephen King either. J.K. Rowling published a book called The Cuckoo’s Calling under the pen name Robert Galbraith only to be outed by someone performing advanced text analysis with a computer. Shortly after the public discovered Galbraith was Rowling, The Cuckoo’s Calling increased in sales by over 150,000% shooting to the #3 on Amazon’s bestseller list after previously being ranked 4,709th.

Both King and Rowling’s foray into undercover writing reveals a harsh truth about success and social status — winners keep winning. This idea is formally known as cumulative advantage, or the Matthew effect, and explains how those who start with an advantage relative to others can retain that advantage over long periods of time. This effect has also been shown to describe how music gets popular, but applies to any domain that can result in fame or social status. I discovered this concept by reading Michael Mauboussin’s The Success Equation where he writes:

The Matthew effect explains how two people can start in nearly the same place and end up worlds apart. In these kinds of systems, initial conditions matter. And as time goes on, they matter more and more.

This explains how King and Rowling sell millions while Bachman and Galbraith don’t, despite being of similar quality. While I find these anecdotes and others useful, we can illustrate cumulative advantage using a simple simulation.

 Related: The Real Reason for Rising Interest Rates

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Steve Smith

Steve Smith have been involved in all facets of the investment industry in a variety of roles ranging from speculator, educator, manager and advisor. This has taken him from the trading floors of Chicago to hedge funds on Wall Street to the world online. From 1987 to 1996, he served as a market maker at the Chicago Board of Options Exchange (CBOE) and Chicago Board of Trade (CBOT). From 1997 to 2007, he was a Senior Columnist and Managing Editor for TheStreet.com, handling their Option Alert and Short Report newsletters. The Option Alert was awarded the MIN “best business newsletter” in 2006. From 2009 to 2013, Smith was a Senior Columnist and Managing Editor for Minyanville’s OptionSmith newsletter, as well as a Risk Manager Consultant for New Vernon Capital LLC. Smith acted as an advisor to build models and option strategies to reduce portfolio exposure and enhance returns for the four main funds. Since 2015, he has worked for Adam Mesh Trading Group. There, he has managed Options360 and Earning 360, been co-leader of Option Academy, and contributed to The Option Specialist website.

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