Is trading gambling? Does it matter what you call it? And which implications does it have for you?
Gambling is the wagering of money or something of value (referred to as “the stakes”) on an event with an uncertain outcome with the primary intent of winning additional money and/or material goods. [source]
the act or practice of risking the loss of something important by taking a chance […] [source]
As a trader, you risk money (where the exact amount isn’t even predefined on the start) on an uncertain event (the movement of a financial instrument which has unlimited uncertain outcomes) with the goal to make more money (how much you don’t even know beforehand).
What is an edge?
An edge is something, a skill or a method, that allows you to tip the odds in your favor – usually just by a tiny bit. An edge makes trading, potentially, less risky because the expectancy potentially becomes positive.
Being able to read the price very effectively in order to time and manage trades can be a part of an edge; emotional stability, a high level of discipline, understanding how to manage risk and deal with variance, being able to work extremely hard, and being passionate are all parts of an edge as well.
However, even the best edge will not remove the risk and the uncertainty completely.
In trading, having an edge will not guarantee anything. Even worse, unlike other games of chance where the possible outcomes are predefined – there are only so many numbers in a roulette wheel or cards in a deck – in trading, we are exposed to ‘black swan events’ which occur completely unexpected with outcomes that no one can plan for in advance. The ways financial markets can move are limitless.
An edge is an important thing to have but it doesn’t make trading less of a gambling activity.
Our whole life is a gamble
The good news is that gambling is totally OK and you should not get too hung up on this term or the negative connotations that come with it.
All our lives, we are gambling – not always by directly wagering money initially, but usually by betting something of value, often our time, for something that we hope will put us in a better spot later on.
When we pick our subject in college, we exchange a few years of our lives and eliminate lots of other opportunities and possibilities in the future just because we think that this subject will lead to a profession that we will enjoy and bring us enough income to live a good life. Not everyone who leaves college or university will like their job though, let alone find a good job in the first place. We exchange many years of our life for studies where we don’t even know the odds of a favorable outcome. Our edge? Consulting friends and family, googling for college rankings and listening to ourselves.
When we choose a job, we, again, exchange our time and we say no to other job offers and opportunities. We then hope that the company we choose will exist long enough, provide us with a good salary, fair promotion suspects, decent retirement plans and friendly bosses and co-workers. But we have no way of knowing that and although living the 9-5 job is always seen as the ‘safe’ way, nothing is guaranteed and we are acting on hopes and with a lot of uncertainty.
Entrepreneurs and shop owners are also gambling and they provide a service, where they sell their time and resources or offer a product. They have to invest money upfront and wage it, hoping that potential customers, which they often don’t have yet, value it so much that they can turn a profit. However, the outcome is uncertain and the wager is either time or money (mostly both). The edge? Research, personal skills, hard work, endurance and the need for good sales and marketing expertise.
When we buy a house and take credit, we gamble that our job will allow us to pay off the mortgage, we decide not to buy other things with the money instead. We hope that our marriage holds, that children will follow to fill the house and that the city and environment will stay nice. Can we know any of that? Of course not but we still take the risk because we believe that the odds are good enough and the upside is worth it.
When we choose a mate, we hope that the relationship will last for a long time, allow us to reproduce our genes, have a companion that we can grow old with and support us during hardships and old age. With a marriage, we are also invested financially in a big way. Seeing the high divorce rate and the people who aren’t fully happy, this seems like a high-risk bet but many people still make it.
Gambling in trading
I could probably go on forever but I think you get the point. We gamble all our lives, even if we don’t call it that, and we have to accept that trading is one of the purest forms of gambling.
You have to accept that you are in an activity where the odds are not necessarily in your favor at all times and that the unique characteristics of trading make it essential that you have good protection and risk control mechanisms.
Good vs bad bets
Ok, let me conclude by saying that taking risks and gambling is not something you need to avoid and if the upside seems good enough for you so that you can live with the negative outcome as well, go for it by all means. Of course, there are things and bets where the odds will always be against us, or where the downside is so huge that it can’t make up for the upside, but here you need some common sense…
When it comes to trading, here are reasons for “bad bets” and “bad gambling” where the odds are not in your favor and a favorable outcome is unlikely or impossible:
- A trader who keeps changing his trading system frequently
- A trader without a structure, not knowing when to trade and when to sit out
- A trader who does not adhere to risk management principles
- A trader who cuts his winners too short and lets losses run
- An impulsive trader who doesn’t have discipline
Taking (calculated) risks is what makes life fun and interesting and it is what makes trading, potentially, profitable. However, most traders are only dabbling around, engaging in bets and trades where they have no edge.
The quote “not taking any risks is the greatest risk” is so true and even if you don’t realize it and you might think that you are going the ‘safe’ way, there are always opportunity costs and you might be wagering your time – which, after all, is our most precious asset.