Six Lessons Investors Can Learn From Gamblers

8th Nov '23 by Mark Simpson

4 comments 653 reads

Is investing a form of gambling?

One of the common misconceptions amongst the general public is that investing is simply a form of gambling. It can sometimes feel like it is even to investors. Especially in current markets where small caps can move up or down over 10% daily on no news. This year, investing in the FTSE All Share has been little better, with rapid moves up and down in a largely range-bound market:

Despite this, two key distinctions mean investing is not gambling:

The first is that investors own an asset. That is part ownership of a company that makes sales and profits, which it reinvests into growth or returns to shareholders (or it intends to do these things in the future). In contrast, a gambler is wagering on an uncertain outcome via a contract with an external party, without owning an asset. Bets are not usually transferrable either, whereas the point of investing in a listed stock is that it can be sold at any time (within market hours).
Secondly, an investment has a positive expected return. On average and over the long term, stocks generate a return above the rate that can be earned in short-term government bonds, the so-called risk-free rate. This difference is known as the equity risk premium and is the excess return the average stock market investor receives. In contrast, a gambler bets against a “House” who sets up the wager or prices the odds so that the expected return is always negative. A sensible gambler only bets when they believe an individual bet has a positive expected return. I.e. they think that the odds offered do not reflect the odds in reality. However, in aggregate, the system is set up such that gamblers have a negative expected return. The house always wins.

It is possible to think of many cases which meet one but not both of these criteria. For example, mathematician Ed Thorp famously devised a system of card counting at Blackjack. He bet minimally when the deck was unfavourable and aggressively when the cards were stacked in his favour. He calculated that this gave him a positive expected return. Which it did do, and for many others, too, when he wrote a book about it called Beat the Dealer. However, casinos quickly adapted the game to introduce multiple decks…

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welwichia

8th Nov '23

thanks very much Mark - really enjoyed this well written post!

Wolf of Small Street

I would say investing is very much like gambling but with lots of extra levers available to pull. The difference compared to slot machines, roulette or horse racing is it's perfectly possible to beat the market on a regular basis over decades. Imagine a horse race where you see all previous stats, see who the major backers of the horse are, then after watching it run (not performing as expected) we have the option of selling and getting 85-90% of our money back.

The little guy has several advantages over funds. 95% of professionals can't even beat a tracker index and have one hand tied behind their back by certain rules, so I don't want to follow what they're doing.

Private investors can go 100% in one company or 100% cash. Can short or hedge, can spread money over 5 companies or 500 and can set stop losses. Have the ability to get in or out of shares at speed at only a couple of quid a trade. Stockopedia or sharepad give private investors almost all the information they need to make rational decisions now, which was difficult and time lagging when I started. Really, it's a fabulous time to be a private investor.

When a market is toppy we can move to a % of cash and wait. The old investment cycle chart where the markets rolls over and people kid themselves it doesn't matter about paper losses because they're long term investors anyway, then start quoting Buffett. That's the danger point. Private investors can exit positions it might take funds weeks or months to get out. On the flip side we can be aggressive buyers when professionals are forced sellers

Theres some exceptional long term private investors who definitely wouldn't consider themselves gamblers but I'd say you need to be v good at accounting, have the ability to really look in depth at a company and have the patience of a monk . A chunk of private investors tho act like gamblers but restrict themselves with Buffett style rules, then lose discipline when panic sets in so it's the worst of both worlds.

Neil81

This assumes you are an exoert in "When to Sell". Not many people are!

I wouldn't say you need to be an expert in anything, just willing to weigh up risk/reward, put the time in (years) and have basic common sense. Eg. Don't watch something go up 40%, then allow all the gains to evaporate.

Six lessons investors can learn from gamblers

Is investing a form of gambling?

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Mark Simpson

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