The Thin Red Line Between Gambling and Trading
Knowingly or unknowingly, most people who are investing are also trading – be it real estate, commodities, precious metals or stocks. Speculation is part and parcel of investing or trading. Investors tend to take a longer view of both past performance and future outcomes. They are relatively more risk-averse than traders. Traders are speculators with shorter time frames, give more importance to recent past performance and events – they aim to book profits when they feel their target was achieved. Traders thrive on risk for a higher reward and constantly on the lookout for opportunities to carve out a gain. Even though both investors and traders maybe called speculators since they share a common trait – they see a probability of a certain event or action from which they can make a profit from the investment made. They may be wrong at times and they may be right at other times, but varying degree of observation, consideration, reflection or some form of logical analysis is the driving force behind their investment. Very rarely do investors or traders make any investment based on their gut feel without some form of analytical thinking.
So how is speculation different from gambling? Gambling is a game – It is really worth winning but not worth playing with money with the intention of gaining it back. The chances of winning are low in gambling – The occasional winner makes millions, but that would rather an exceptional case – if not the gambling house would be out of business in no time.
Speculari is an ancient Roman activity which means to watch or to spy. Later on evolved into the act of speculating which was used to denote the act of looking ahead in business. Speculation assumes that a certain outcome is possible, probable and sometime with a certain degree of certainty. Good speculators know beforehand the probability of failure, risk of loss from a negative outcome and the reward from a positive outcome.
Simply put, when money is placed on a bet that has a negative expected value, is called gambling. At times, a gambler might get lucky and make a fortune – but in most cases, this would be an unexpected and non-frequent event. Placing these bets many times will lead to long term losses.
There is a very thin line between trading and gambling that most traders unknowing cross – in the process they lose money. In the long run, trading strategies with positive risk:reward is better than trading a high win rate negative risk:reward strategy. It is very important to know how to evaluate a trading strategy before trading it. Negative risk:reward systems, Grid and Martingale strategies are all close to the border line gambling strategies where luck plays a major role.
Trading requires establishing a set of rules and testing those rules over a large number of trades to determine the expected value of the trading strategy. Trading has a positive expected value. Trading is treated and executed like any normal business transaction – Investing a certain amount of capital with an acceptable risk for a certain duration of time to derive a profit. Trading always involves a strategy – More traders lose due to lack of discipline in implementing a planned trading strategy rather than the strategy itself.