Using Gambling to Learn about Investing

At "A Dash" we have tried to draw a clear distinction between investing and gambling.  We believe that the analysis of gambling situations frequently provides more data, allowing a long-run analysis.  The techniques used are the same that investors should use in evaluating stocks and sectors.

The Danger

Those buying stocks, whether their time frame is short-term or long-term, frequently focus on the return rather than the risk.  This can take two distinct forms:

1. Believing in the apparent consistency of returns.  This has been costly for investors in mortgage securities, either directly or through hedge funds that leveraged these instruments.
2. Swinging for the fences.  The investor looks at the potential gain rather than the risk.

The Gambling Lesson

Seeing the risk/reward error is extremely difficult when one already has an investment position.  The  gambling comparison can help one take a completely different perspective -- one where there is no  psychic stake in the outcome.

Accrued Interest  provides several lessons on this theme in an excellent post today.  The points are difficult to summarize, so we recommend reading the entire article.

Tom Murcko at InvestorGuide.com also provides a thoughtful comparison  of investing and gambling,  including a good intellectual framework.

Our own comparison is also helpful.

Conclusion

Looking for understanding from different, but analogous situations, is a strong method for improving investment performance.

Many approaches are working well, but investors need to choose with a realistic assessment of risks.

Comments

[vigilon]

I think there a great disparity between the two. Though they maybe both games of chance since they involve probabilities where you put money at risk with the hope of a return, and both can make your hard earned savings vanish when you bet wrong. The difference boils down to one simple concept that sounds intimidating but is actually easy to understand – mathematical expectation.

[Objective Stock Investing]

To improve the probability of long term investing success investors should seek a fully documented investment tool to improve their decision making. While their is never a guarantee of success, working with a validated process increases the prospects of finding a rational stock trading strategy that really works.

[muckdog]

Does the House have the advantage in the stock market? LOL. I guess if the House is the SP500, then the answer is yes since most folks who do anything other than buy and hold end up underperforming the SP500.

Plus, no free drinks at the stock market casino.

If the long term average of the SP500 annualizes to an 8-10% return per year, then the consistancy of returns is there assuming a long-term time horizon. Even though past results can't predict future returns. The rub comes when folks try to beat that "boring" 8-10% return; they end up underperforming it.