Investing is not Gambling

Since there is a long-term positive expectancy in equity investments, buying stocks is not a gamble in the normal sense -- a lottery ticket, a trip to the track, or a basketball pool.  Why do so many investment authors use gambling terminology and analysis?

There are two very good reasons.

1. Gambling activities often permit an exact calculation of odds and edge (positive or negative).  This means that the action can be simulated, modeled, and analyzed.  The study of risk and reward has drawn many serious economists, mathemeticians, and other scholars into the realm of gambling.
2. The examples may be easier to understand than those from the investment world.  In explaining to clients why certain ideas are silly, a sports or racing analogy often makes it clear.

William Poundstone's book, Fortune's Formula, provides an interesting trip into this world.  I cannot really remember a book featuring both gangsters and academics, both separately and face-to-face.  Poundstone describes the efforts of brilliant scientists exploring information theory, the travels between blackjack and investment management of Edward O. Thorp, and some insight into why certain strategies work and others do not.

Much of the book is a debate over the Kelly Criterion, a method of money management that optimizes the size of individual investments.  Some economists dispute this idea, so there is a lively and informative discussion between the information theorists and the economists.

A mistake made by many investors (and even more gamblers) is a failure to understand risk, even when they have significant edge on a specific trade.  Poor money management cannot turn a losing system into a winner, but it can turn a winning system into a big loser.

Comments

[casino bonus list]

The stock market is definitely a gamble. i am not sure why you are saying this.

[Bill aka NO DooDahs!]

One **possible** delineation:

If the game is structured in such a way that the "player" cannot move the odds in their favor, even slightly, then it is gambling.

If the "player" can potentially devise strategies that move the odds in their favor, whether or not the player actually does this, then it is speculation.

For what it's worth, this delineation would put blackjack, and all competitive card games against non-house competitors, in the "speculation" camp. I'm not endorsing this delineation, and depending on my mood, I'm sometimes inclined to call trading "gambling," but regardless of the label, it **IS** an important delineation.

[oldprof]

Joe -

No money management system can turn a method that has a losing expectancy into a winner.

A poor money management system can turn even the best plan into a loser.

Your question is excellent, and frequently misunderstood by both investors and gamblers.

thanks,

Jeff

[Joe B]

positive progression when winning. win streaks and losing streaks. can it buck the systems?

[Jeff]

Anonymous --

(and others who may have this same impression)

The distinction I am explaining here involves the long-run expectancy and money management. Suppose you have a proposition (a stock or a biased coin) that pays an even-money bet 55% of the time. If you bet everything on one event, that is certainly a gamble. If you made a lot of smaller "bets", it is not.

[anonymous]

You have an odd definition of "gamble".

http://www.thefreedictionary.com/gambling

gam·ble (gmbl)
v. gam·bled, gam·bling, gam·bles
v.intr.
1.
a. To bet on an uncertain outcome, as of a contest.
b. To play a game of chance for stakes.