Gambling vs. Trading

• Posted by Derek
• on March 31st, 2010

“Gambling is taking a risk when the odds are against you.  Speculating is taking a risk when the odds are in your favor.”  Victor Sperandeo

This quote stuck with me since I first read Trader Vic: Methods of a Wall Street Master, still one of my favorite books.  A number of stories lately have reminded me of the comparisons and contrasts between gambling and market speculation.  The first was a Wealthtrack interview(HT @researchpuzzler) with Bruce Berkowitz of Fairholme Funds, recently named Morningstar Fund Manager of the Decade.

He talks of dropping out of high school as a 15 year old to run his bookie business, and the lessons learned.  I can relate, as I was known to book a few bets in my teenage years.  Not enough to consider dropping out of school, but enough to pick up lessons that would shape the way I later viewed financial markets.  The hope, fear, and greed so influential in markets became obvious to me at a young age.  Funny how the largest bets would always be on a midnight Hawaii game, and of course the Monday night NFL game.  The desire to breakeven is overwhelming for those at a loss, so accepting behavioral finance was a no-brainer for me.

Another story highlighting some parallels with gambling came from Dr. Brett Steenbarger, discussing the signs of trading addiction as though he was talking about gambling.  Anyone participating in trading or investing knows how easy it is to overwatch, overtrade, rationalize loss, etc.  The first thing a new trader needs to do is recognize destructive behavior, and create a plan for protecting you from yourself.

Finally, a tweet from @milktrader pointed out that “the only difference between gambling and trading is that your amount at risk and amount of potential reward varies with trading.”  I agree, but there’s more to it.  The parallels are obvious, from the lack of control over outcome to the illusion of knowledge to the physiological effects of having a stake in the outcome.  However, the differences are substantial…and mostly mathematical.

The expectancy in gambling is ALWAYS terrible, while market speculation at times offers outstanding opportunities.  To get a 2:1 or 3:1 opportunity in gambling, one needs to accept incredibly low odds of victory.  In financial markets, those 2:1 or above opportunities come around like clockwork and offer high enough probability that long-term positive expectancy is possible.  Not only that, but the market speculator has the opportunity to adjust his or her position after the game begins…when was the last horse race where you could take a little off the table after the first turn?  Or reclaim most of your bet when your horse stumbles out of the gate?

I’ll leave the neuroscience to the experts, but it seems to me that we need to coordinate our left brain(rational) and right brain(experiential) in laying out the role of each.  We want to allow our intuition to shine through, but within the overall structure of positive expectancy.  No matter how hard one tries, the math of gambling can’t come close to touching the opportunities for building a business out of the markets.

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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