Saturday, 27 September 2014

Quote for the day

“There is nothing like losing all you have in the world for teaching you what not to do. And when you know what not to do in order not to lose money, you begin to learn what to do in order to win. Did you get that? You begin to learn!” - Reminiscences of a Stock Operator

What is the difference between trading and gambling?

By David Hunt

For me the difference between gambling in trading is as follows (bear in mind I like to have a position that lasts more than an hour!)

Gambling is, usually, an event with:

Limited duration
* Finite upside
* Finite downside
* Binary outcome

When you gamble you either win or lose. That event usually takes only a small amount of time.

For example, you can bet on a horserace 10 minutes before it starts and 5 minutes later you have a result. For anyone who plays poker, you know it may take a little bit more time as the stakes are raised. So poker is a little bit closer to trading.

In gambling your risk on any event is usually what you outlay. And your potential return is what the house is offering at the time you agree to the bet.

I love to play blackjack (and for some reason, while I don’t play often, I have been profitable almost every time I’ve played in the last 3 years) like one of my trading mentors who was an original Turtle Trader.

A bet on a Blackjack table can take a minute or two until it’s over. 

Whereas in trading, a trade has the following characteristics:
* There is no house to limit the upside on a trade.
* Aside from options and non-rolled over futures contracts, there is no time limit to restrict the downside on a trade.

So a trade can grow and make unlimited upside in theory. And a trade can also melt your account down if left open and it’s leveraged.

So the real difference is in most forms of gambling a gambler has to continually repeat similar actions to make his money or lose it!

Whereas in trading, if a trade becomes profitable the trader can hold her positions and not make any changes as long as the trend unfolds.

In statistical terms, this would be called “having fat tails”.

The fat tails are outliers which are events that go past the normal distribution you would expect from a population of outcomes.

I had a great example in my life of buying some shares when I was 21 and holding them and watching them grow big enough that my ex-wife’s lawyers really wanted to get a hold of them and eventually did! Divorce lawyers are the ultimate profit target…

Now, for those of you who play poker you will know than when a poker player ups her ante when she has a strong hand (or skilfully hides her bad hand and bluffs around) the stakes can escalate and outliers can be found out of the pot! So poker has greater similarities to trading than most other gambling activities.

My friend who was one of the Original Turtles said that he owed his employment by Richard Dennis to one book. And it was about gambling. This is a cherished part of my library.

So basically in trading you can take all the time in the world to make (or lose) all the money that you can on one event. Whereas in gambling you have a short time to make (or lose) a limited amount of money.

Now let’s not get into the debate about trading versus investing! The only difference I see in that is timing and focus.

In trading, the only thing you need to do when you get into a good trade is manage stop loss.

How are they similar?
* Good trading requires consistency as does gambling, yet they both require you to be able to step away when the tide is not in your favour.
* Both trading and gambling require emotional control to be successful in the long run.
* The odds on the statistics in both trading and gambling are against the average player. So both trading and gambling require successful people to be against the majority because the majority are losers in the markets. You have to “think different”.

Now I haven’t gone through all the emotional pressures. With traders generally we are a lonely bunch and that requires getting some social interaction going whereas many forms of gambling have a community feel. Even online poker players develop a community!

David Hunt is one of Australia’s leading market analysts and chief strategist at Profit Hunters, with more than 30 years’ financial markets experience in shares, forex, futures and commodities. Referred to as the “Bell Ringer” by the Australian Financial Review, David’s success and defined opinions are highly regarded by the professionals in the industry… due to his accuracy.