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What March Madness has in common with stock picking

University of Louisville's Montrezl Harrell reacts after dunking the basketball over North Carolina A&T's defense during the first half of their second round NCAA basketball game at the Rupp Arena in Lexington, Kentucky, March 21, 2013. My investor pal Craig currently sits securely in first place in his pool, which has entrants from several firms in the Toronto financial district. But the tournament, like the market, can change quickly and he is counting on Louisville to beat Miami in the final game to maintain his position.


March Madness has taken over the North American workplace. Over three long weekends, beginning in the middle of March, 68 American college basket teams compete in a sudden-death elimination tournament for the right to be named the champions of U.S. The tournament reaches far beyond hard-core college basketball fans into every sector, especially into the investment industry.

The frenzy is driven by office pools with millions of people trying to pick the winners of all the games. One survey estimates that 58 per cent of workers in North America will wager about $12-billion over the course of the tournament. The tournament's popularity is driven by its egalitarianism. It is hard to follow that many teams closely, and at the college level the sport is capricious, so even the experts don't have a particular advantage.

Still, just as the investment industry doesn't consider investing in the stock market to be gambling, the poolies following the U.S. college basketball tournament believe that their choices are based on facts and analysis, not chance. But the tools of the trade are similar and the overlap of assessment techniques is eerily similar.

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I turned to my Bay Street friend, Craig, for advice about how to apply March Madness methodology to investment success. Craig is a superb stock picker and he overwhelms just about every sports pool that he enters.

"The key is to remove emotion from the equation, and instead stick to a strict philosophical process," Craig explains. "There are different styles to filling out a bracket. You can either take the value approach, where you pick mainly underdogs, and hope for the big upsets. Or, you go for the growth/momentum approach, where you pick mainly favourites who are highly-ranked.

"The style that I implement, both in investing and in bracketology, is GARP, or growth at a reasonable price. Through in-depth, detailed, analytical, fundamental and statistical research, I try to pick the best teams that are slightly under-appreciated, or are less well known. I try to find the rising stars that have been improving as the season progressed, and possess the unquantifiable intangibles that don't appear in the archetypal rankings."

Craig currently sits securely in first place in his pool, which has entrants from several firms in the Toronto financial district. But the tournament, like the market, can change quickly and he is counting on Louisville to beat Miami in the final game to maintain his position.

Dan Heath is the author, along with his brother, Chip, of Decisive: How to Make Better Choices in Life and Work. He used the psychological framework that forms the basis of his book for "The Four Secrets of Bracket Psychology," a recent article he wrote for the Wall Street Journal. While his article is about the tournament, the principles can also apply to investing:

1. Distance yourself from emotion before deciding
Heath warns not to pick a team just because you like the colour of its uniform. Don't pick a team just because it's where you went to college. He says that "we develop a preference for things merely because they are familiar." This might sound counter to the famous Peter Lynch mantra: "invest in what you know."

2. Prepare to be wrong
Over-confidence, he says, is a well documented psychological bias. You can never be too sure. Heath suggests filling out more than one bracket and making variations. In investing, we call it hedging.

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3. Avoid confirmation bias
We tend to seek out information that flatters our existing beliefs while avoiding contrary evidence.

4. Honour your core priorities
Be clear about what you want to achieve. It is easy to pick the better seed in every game. But if you are investing on the principle of finding value, then it is okay to make an unorthodox decision, as long as it is based on good research.

One last thing. Sometimes it pays to question accepted wisdom. Basketball aficionados talk about the "hot hand." They think that if a player makes two or three baskets in a row, he stands a better chance of making the next shot, or if a team is on a streak, the streak will continue through the tournament. In reality, everything reverts to the mean eventually. So if a stock is performing unusually without explanation, don't bet that the streak will continue.

In the interest of full disclosure, I have to confess that the bracket I chose is pretty well done. I have four teams left in the round of 16, with only one that could be in the final four. In basketball, I do follow my emotions, rooting for the underdogs and picking long shots. It's a good thing I won't have to retire on my basketball winnings.

READERS: Do you find sports pools offer lessons for the rational investor?

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