Market Tales: Neopians and Stock Investment Risks

Fortunately, most of you already know the most basic principles of investing. Let's see what these principles are, and let's see how some Neopian entrepreneurs put these principles into action.

Diversification is good

I rode along with Alhazad the Trader on one of his fast-paced buy-and-sell days. We spent the day shuttling back and forth between the Lost Desert in the south and Neopia Central in the north, stopping at Kiko Lake and the Haunted Woods both ways.

In between sales visits, I asked Alhazad questions about what he had in the trunks on the back of his flying carpet.

"Oh, I have sunglasses in that one, raincoats in that one, and umbrellas in that one," the lively Wocky said. "That's what we call diversification!"

Alhazad explained that he recently entered the sunglasses-umbrellas-raincoats market. He rarely gets to sell sunglasses, raincoats, and umbrellas on the same day at the same place, but that, he said, was precisely the point.

"If it rains, then I sell a lot of umbrellas and raincoats to my loyal vendors and distributors. If it is sunny, then I sell a lot of sunglasses. Some vendors also buy umbrellas on sunny days because many tourists buy umbrellas for shade. If it is cloudy, then I sell a few umbrellas to vendors who want to prepare for an increase in demand if it rains.

"By diversifying my wares," Alhazad said, talking loudly into the wind as the carpet took off, "I reduce the risk of losing money because I can always sell something rain or shine!"

What does Alhazad's personal experience mean for those of us who want to invest in the Neopian Stock Market? The answer is clear: if you invest all of your NP in one company in the Neopian Stock Market, then you will not earn very much if that company doesn't grow. Worse, you will lose all of that money if the company goes bankrupt. Diversification is a great way to reduce risk!

Diversification is not that good

At the end of our day, Alhazad and I had dinner at Sakhmet, and he explained to me that diversification reduces risk but doesn't completely eliminate risk.

"One rainy day," Alhazad said, pushing aside his plate of Sphinx Links, "I sold all of my umbrellas and raincoats. I had not one left. I felt most foolish when I opened my trunks and discovered nothing but sunglasses left. Alas, if I had invested more in umbrellas and less in sunglasses, then I would have made more money!

"As a merchant you learn not to put your Neggs in one basket," Alhazad said. "I currently invest in sunglasses, umbrellas, and raincoats. I put my Neggs in three baskets. However, Neggs are Neggs are Neggs; they can still break! I still lose money, as I did on that rainy day when I brought more sunglasses than umbrellas!"

Diversification is not that simple

Alhazad's parting words were rather smart. "In the past year, for each day when I felt bad about a diversification choice, there were seven more days when I felt good. The market, like weather, is fickle. Because I diversify, I earn money on more days than my competitors who do not diversify."

For more lessons on diversifying wisely, I talked to Remnok the Nomad the next day. Many of you know Remnok the Nomad as the battle equipment vendor in the beautiful city of Sakhmet.

"I spend my time searching for weapons in the ruins of the Lost Desert," Remnok said. "However, I only have a limited amount of time. Therefore, I do not spend that time searching for other wares. For instance, I do not trade in medicine or pottery."

Remnok diversifies (he sells a wide variety of items), but he doesn't try to sell everything under the sun. Remnok's system is to diversify while maintaining some focus.

What does this mean for Stock Market investors? You can only buy 1,000 shares a day at the Neopian Stock Market. Let's look at two hypothetical situations:

Plan A: You buy 100 shares each from 10 different companies. Buying from 10 different companies increases your chances of having invested in a winner. If nine out of the ten companies fail to grow, then you can still sell the stocks of the tenth company for a profit. However, it's a very small profit: if you bought 100 shares at 15 NP and sold your 100 shares at 30 NP, then you earned 1,500 NP. We can call this a low-risk plan.

Plan B: You can buy 500 shares from 2 companies. Buying from fewer companies means less chances of "backing a winner"; both companies can fail, and you're stuck with a loss. However, if one of those companies grows quickly, then you can sell those stocks for a big profit. If you had 500 shares in one company at 15 NP per share, and if you sold at 30 NP, then you earned 7,500 NP (instead of the 1,500 NP in Plan A above). We can call this a higher-risk but higher-profit plan.

As you can see above, risk and reward go hand in hand. As Alhazad said, Neggs are Neggs regardless of how many baskets you keep them in. There is always a risk. For example, if none of the companies you invested in grows, then you won't make a profit at all. That is part of the risk.

Every potential reward carries a potential risk

"All investments carry some risk. The potential to bring in a huge return is always there, but only if you're willing to entertain the risk," said an anonymous market analyst from Balthazar's Faerie Bottling Incorporated (BFBI; Neodaq: BOTT) in a telephone interview. I tried to reach Balthazar himself, but he was unavailable.

In our interview, the analyst mentioned the December 21, 2008, bonanza for Achyfi Enterprises (ACFI) investors. ACFI rose beyond 60 NP on that day. Many investors who bought at 15 NP enjoyed a 400% profit. "Some of my friends took home over 600,000 NP on that day," said my source. "But, they had been holding on to their stocks for weeks - in some cases months."

What if you had ACFI shares and did not sell your shares, choosing instead to wait for ACFI to reach 200 NP? I put that question to my source from BFBI. She explained that ACFI has dropped to 20 NP, so those investors who want to wait for ACFI to reach 200 NP have a long, long wait ahead of them.

She also suggested that people still holding on to their ACFI shares should liquidate those shares and instead invest in BFBI (Neodaq: BOTT) because BFBI has always been a popular choice among investors (except, for some reason, in Faerieland).

I asked her if she was serious - that is, I asked her when was the last time that BOTT was in the upper 60s, and she hung up. I guess I'll never get that interview with Balthazar.

It is a game

The choices you have to make - when to buy, what to buy, how much to buy, how long to wait, when to sell, what to sell, and how much to sell - these depend on how you want to play the game. After all, the Neopian Stock Market is a rather fun game.

How you play depends on how long you're willing to wait for your financial investment to mature. For example, if you have a lot of money in the bank, then that means that you won't need to sell off your stocks for emergency purchases and you can wait for weeks or even months as the Stock Market goes up and down and up and down.

On the other hand, a new investor with a lot of expenses (such as having three pets to send to Cap'n Threelegs' Swashbuckling Academy and the Mystery Island Training School each day) and not enough money in the bank often needs to sell his or her stocks before the stocks fully mature.

Let's look at two case studies...

Short time horizon; low tolerance for risk: Pacha the Vet runs a Petpet clinic. I talked to an anonymous source close to the Elephante and learned that Pacha can't tolerate too much risk and tends to be a play-it-safe investor.

"Taking care of Petpets is expensive and Pacha takes care of a lot of homeless or injured Petpets," my anonymous source said. "So, when Pacha invests, he looks for short-term, low-risk investments because he often finds himself needing to sell his shares before they mature. He also diversifies quite a lot!"

I talked to Pacha and learned (after translating every UGGA UGGA) that he recently adopted a new system: he buys 250 stocks from 4 different companies each day and sells after the stocks go up by 5 points.

Long time horizon; high tolerance for risk: The Undead Grundo Shopkeeper, on the other hand, can wait for ages. He's already dead, and his wares are already rotten. He can wait for as long as it takes for a stock to mature.

I asked the Grundo about his investment strategy, and he said "Groan gurgle gurgle moan gurgle gurgle groan gurgle moan moan gurgle snort gurgle ..." He was still gurgling when I left.

According to reports from other investors in the the Haunted Woods, the Undead Grundo Shopkeeper has some stocks that he bought 18 months ago. He's still waiting for them to reach 60 NP! This slow-but-steady systematic method means that the Undead Grundo Shopkeeper will make a lot of money when he sells his shares at 60 NP when that opportunity finally arrives (or if that time arrives, because there's always a risk that a company will go bankrupt). Some sources estimate that the Grundo earned nearly 1,480,000 NP in the last fiscal year alone.

Everything is a gamble

A few days before I sat down to write this article, I asked some famous Neopians what they thought about my above findings. As of press time, only one has responded.

Nigel the Commodity Broker Chia believes that the all Neopians should look into hiring asset managers and should read the News/Research page at the Neopian Stock Market each day. "Look at it this way: you can take home 500,000 NP if you wait 12 months for your shares to reach 100 NP. But if you wait 2 months to sell at 60 NP, then wait 2 months for the stock to drop to 15 NP so you can buy more shares again, and then wait another 2 months to sell at 60 NP, then you made about as much in only half the time!"

I asked Nigel about the odds that a stock will do exactly what he said (go up to 60, go down to 15, then go up to 60 again in only 6 months), and Nigel was quick to respond with a disclaimer. "Well, I didn't actually say that such an event would actually happen."

I also asked him about allegations that the News/Research page wasn't accurate, that the Neopian Stock Market is really just random, that all this randomness means we should just diversify at random, and that none of the advice from Alhazad and Remnok and others is actually applicable to the Neopian Stock Market. Nigel's quick answer is something that all of us should consider: "I think you should read the fine print," Nigel said. "I already mentioned somewhere that everything is a gamble."

ABOUT THE AUTHOR: Maxwerx is an amateur investor in the Neopian Stock Market. He is not an expert. The above article is, in his words, "an article based on a few conversations with a Wocky on a flying carpet, a bunch of anonymous sources, and a Chia who adds a disclaimer to everything - in other words, it's all rather interesting, academically speaking, but none of what I've written should be constituted as practical advice."