THE BIG DEBATE

Is trading the same as gambling? One of the best articles ever produced around this question was published at Futuresmag.com back in July 2013. The article was written by Michael Gutmann, a software engineer and manager at Intel Corp. He is an expert at building and analyzing quantitative trading strategies, which he has written about extensively so his opinion about trading and gambling was of great interest to me as he was someone who understands the nature of probability and how this ties into speculating.

Trading and gambling are similar in that they both attempt to create a capital gain, over a relatively short period of time, without creating new wealth. If I am a shoemaker, then my efforts create a pair of shoes that someone else can wear (new wealth), while I earn an income from cobbling. When I am a trader or gambler, I may earn an income, but there is no additional wealth created. Some markets experts would claim traders create market liquidity to the benefit of long-term investors, and that this in itself has value, similar to “new wealth” creation. But because trading and gambling involve capital transfer without capital creation they are viewed skeptically, especially when their outcomes are unpredictable. Society generally prefers the shoemaker-type endeavor because it creates something others find valuable.

Trading and gambling are both fundamentally stochastic, that is unpredictable, and because of this they are often viewed negatively. We feel an “honest effort” has more predictability to it, and we may hold those who take too much risk in disdain. However, many who have tried their hand at a new business will attest to significant luck when successful. The goal of new wealth creation, and the time needed to develop a successful business, act to mitigate the risks involved. But then, traders and gamblers will often describe many years of practice before becoming successful.

Trading and gambling both occur because, at least at their start, the participants have accrued wealth in excess of what they need to live. This is similar to the investor who possesses excess capital (and typically much more than the average trader or gambler). Investing has a connotation preferable to trading because the investor is viewed as enabling new wealth creation and because it involves delayed gratification – the benefits of a sound investment may take many years to realize – just those attributes described above. There seems to be an inherent respect for a long-term investment that turns out well: The successful investor is considered patient and prescient. On the other hand, trading and gambling have a get-rich-quick aura to them and are often viewed with disdain because of it. In fact, a professional trader or gambler may not get rich quickly, but simply earn income slowly over time.

When modern civilization enabled some individuals to amass wealth in excess to what was needed immediately to survive, speculative trading and gambling naturally evolved, and traders and gamblers may be viewed negatively because they are using money that others do not have. Because no one has yet determined an equitable means of evenly distributing wealth, trading and gambling should not be considered inherently evil. No one objects to an employee retirement fund investing in the stock market: The capital has been amassed and must be somehow managed.

Successful traders and gamblers are typically highly skilled and spend years becoming proficient. Success often means a steady regular income and not a one-time jackpot event. Because society values most activities that require a highly-developed skill, the successful trader or gambler will be viewed in a positive light, while the failed participant is merely seen as one more “loser.”

Both trading and gambling have seen the development of numerous mathematical (and pseudo-mathematical) techniques in order to increase their chances of success. Because the mathematics of trading and gambling can be made precise and add to our understanding of natural events, there is new wealth creation from those who have contributed to defining profitable trading and gambling techniques. Often these individuals are held in esteem while the practitioners of the techniques are not. For example, the Nobel Economics Prize was awarded to the inventors of the Black-Scholes options pricing model, while those who daily use the model’s outputs are viewed merely as traders.

So much for a broad-brush outline of the similarities of trading and gambling; what of their differences?

Gambling is perhaps more self-contained than trading. That is, gambling is about a single game that is played with a set of rules and uninfluenced by outside events. Trading can be conducted as an exercise that is similarly contained – the technician whose only inputs are price charts and technical indicators – but trading typically includes an awareness of external events taking place in the world around the trader: Economic reports; unexpected international events, natural or human-made; trading activities of far-flung participants and other markets. Most traders, whether fundamentalists (those trading on underlying economic activity) or technicians (the chartists) are aware, and attempt to make use, of information that is somewhat tangential to the specific market where they are active. In this sense, the trader is perhaps a bit more connected to the outside world and the ups and down of the global economy than is the Las Vegas black jack gambler, and this perhaps gives the trader greater gravity relative to the gambler.

Traders may view themselves as more technical, even scientific, than gamblers, relying on intricate formulas and algorithms for success, and so they give their endeavor higher marks than gambling. But this argument probably does not stand against the expert card counter or the gambler claiming a vast knowledge of poker hand probabilities. In a similar vein, many traders will argue that it is their conservative money management that distinguishes their trading from gambling. A trader will never put him/herself in a position where one trade can knock them out—well they shouldn’t but it has happened i.e. London Whale. But then, I have listened to poker players expound on the intricacies of managing their stake against other players and the “blinds” used to enter a hand. As with every endeavor, there will be outstanding practitioners of both trading and gambling who will bring a tremendous amount of expertise to the endeavor.

While both trading and gambling are inherently stochastic, or probabilistic, there may be more techniques that can be brought to bear to beat the odds with trading than gambling; or, more simply put, it’s often thought that chance plays a larger role in gambling than in trading. But is that really the case? What about the mathematician Ed Thorpe’s efforts to completely understand the probabilities of blackjack? Thorpe states that he ran literally trillions of test cases on early IBM computers in the 1950s in order to completely model the game. The mathematicians, physicists and computer scientists on Wall Street developing high-frequency algorithmic trading make a case for a greater intellectual effort currently expended on trading. In the end, it probably again comes down to the individual trader and gambler: There will be gamblers who have invested equally in their success relative to the sophisticated trader.

The difference between trading and gambling may come down to the specific properties, or parameters, of the two. Trading pits individuals against a vast market. Gambling generally pits individuals against other individuals (or the house) and perhaps there is more inherent emotion in gambling as a result, though having traded for a number of years, I honestly can’t imagine there being more emotion to gambling than trading.

But, as before, perhaps the only conclusion we can draw from this is that like most everything else in life, it comes down to the individuals involved. There may be more serious traders than gamblers, and there may be more weekend gamblers than inexperienced traders. There may be more simple game playing in gambling, where one goes for a jackpot with friends at the kitchen table, while trading involves an inherently more serious player who is looking to earn a living. Perhaps this is the only real difference between the two. But it is not obvious to me.

Ultimately Gutmann is implying that there are similarities between trading and gambling dependant on the trader and the gambler. However at the time he was not aware that that the sports industry in the UK now had a trading exchange which allow buyers and sellers to come together which completely changes the landscape. Previously speculating in sports was all about a punter going down to his local betting shop to make a wager. Most bets were recreational bets made by men at the local bar with their friends before the start of a live sporting event. But the introduction of an exchange now means we have the added dimension of a new generation of sports traders who trade for a full time living.

So boiling it down to the nuts and bolts, a trader is one who is like a casino extracting more money than he or she loses from the market because of a statistical edge. This is why Dick Weismann's book "Trade Like a Casino" has been such a relevant publication because it delves into the concept of having to become the casino so that you are profiting from the exchange in the same way that a casino over a period of time generates profits from its customer. The casino knows that from time to time a customer will get a huge win but the probabilities are so low that these losses for the casino are more than compensated for by the many many more losses that customers experience.

 


The key to success in trading is the ability to accept losing a battle whilst knowing you are winning the war

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