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Gambling vs. Trading

“Gambling is taking a risk when the odds are against you.  Speculating is taking a risk when the odds are in your favor.”  Victor Sperandeo

“the only difference between gambling and trading is that your amount at risk and amount of potential reward varies with trading.”  I agree, but there’s more to it.  The parallels are obvious, from the lack of control over outcome to the illusion of knowledge to the physiological effects of having a stake in the outcome.  However, the differences are substantial…and mostly mathematical.

The expectancy in gambling is ALWAYS terrible, while market speculation at times offers outstanding opportunities.  To get a 2:1 or 3:1 opportunity in gambling, one needs to accept incredibly low odds of victory.  In financial markets, those 2:1 or above opportunities come around like clockwork and offer high enough probability that long-term positive expectancy is possible.  Not only that, but the market speculator has the opportunity to adjust his or her position after the game begins…when was the last horse race where you could take a little off the table after the first turn?  Or reclaim most of your bet when your horse stumbles out of the gate?

I’ll leave the neuroscience to the experts, but it seems to me that we need to coordinate our left brain(rational) and right brain(experiential) in laying out the role of each.  We want to allow our intuition to shine through, but within the overall structure of positive expectancy.  No matter how hard one tries, the math of gambling can’t come close to touching the opportunities for building a business out of the markets.

Wisdom Trading Quotes

wisdomquotesNot risking is the surest way of losing. If you do not risk, risk eventually comes to you. There is simply no way to avoid taking a risk. If a person postpones taking risks, the time eventually comes when he will either be forced to accept a situation that he does not like or take a risk unprepared.”
Anyone who buys or sells a stock, a bond, or a commodity for profit is speculating if he employs intelligent foresight. If he does not, he is gambling.”
 “Most successful traders at some stage have a breakthrough, an Aha! experience. Often this is not new information, or a new approach, but the time was just right, they had matured and were ready to ‘see’ in a new way, to apprehend things clearly on a conceptual level, rather than a technical level.”

The Emotions of Risk

One book that I frequently recommend is Justin Mamis’ The Nature of Risk: Stock Market Survival and the Meaning of Life (1). I believe this book to be foundational to new traders because it discusses, what else?, the nature of risk in the market. What I love about Mamis’ book is the unique way that he writes about market risk, and the way that he juxtaposes two seemingly opposing ideas, that are not in opposition at all. From that juxtaposition he illuminates. (Read on for an example). Given some of the conversation at the Slope, I wanted to do a brief post on some of his concepts from Chapter 6, The Emotions of Risk. I think that some will find some resonance. I particularly wanted to share some of these concepts that might engage your brain into thinking about risk differently. Mamis posits: “Under pressure, emotions determine our action.” (p. 72) Because risk is typically defined as a peril, fear is one of the primary emotions. “Fear is long-term, an underlying pervasive emotion, like the underlying primary trend of a bear market. It doesn’t go away until it changes.” (p.73) Mamis makes a simple, yet powerful, statement about the pervasive fear needed for stocks to go up. Yes, you read that…to go up. For there to be buyers, there must be sellers. And it is the fear of the sellers that creates the proverbial wall of worry to provide supply for those who have a different perception of current market risk. He also notes that the operative portion of fear is anxiety. Anxiety is what paralyzes and prevents you from taking action. It is this anxiety that “gets in the way of taking a risk.” The flip side of fear is the emotion of greed. The operative emotion of greed is envy. Mamis notes that “. . . whereas anxiety paralyzes, envy cause one to act. . . ” It is difficult to see the spectacular trades/success of others, and not feel a small bite from that evil twin of jealousy, envy. Envy can cause very risk behavior which is simply, “the risk of ‘denial of risk’.” Both greed and anxiety often lead to doing the wrong thing. My sense of this wrong thing is “inertia.” : failing to buy when one should buy; failing to sell when one should sell. These emotions and their operative manifestations into our action (or inaction) govern all market participants. The emotional impetus for buyers/sellers is reversed in bear/bull markets. Regardless of the market participant regalia you dress in each day, it is best to understand both your own and others’ motivations and perceptions of the current risk environment. Mamis’ book came along for me when I was feeling ‘inertia’–that inertia having been brought about by the overwhelming need to have more information, more certainty, more sense of direction. Granted, there is nothing wrong in standing aside when there is great murkiness…but my inertia was spanning a time when there was some market direction, but my emotional state prevented my seeing that. Providence must have set this book into my hands, because it helped me come to terms with that inertia. As market participants, we have to balance the two opposing points off view of being free enough to take risk and while not falling into the trap of ‘the risk of ‘denial of risk.’ (more…)