Is Trading Gambling? Not If You’re Doing It Right
The world of trading is one that some may deem to be synonymous with the high-stakes strategies often associated with the likes of roulette tables and one arm bandits. Simon Ree, the author of the recently released ‘The Tao of Trading’ aims to shed light on this misconception, highlighting the key differences between the luck-based act of gambling, and the strategic and calculated act of trading, and they key ways to ensure that trading doesn’t become a gamble.
By Simon Ree, Founder, Tao Of Trading, and Author, The Tao of Trading: How to Build Abundant Wealth in Any Market Condition
“So, what are you trading these days?”
As an active trader with nearly three decades of experience under my belt, I hear this question often, especially from people who don’t work in the investment industry. This morning, it was coming from a friend over coffee in Singapore.
I briefed him on what I’d made money on recently and what I’d lost some money on, and then I turned the question to him.
“Oh no, no more gambling for me!” he said. “I vowed not to trade stocks after losing a bundle of money after 2008. I’m sticking to ETFs from now on.”
The idea that seeking a steady income from the stock market through trading is the same as gambling has never gelled with me. Trading and gambling differ in several ways, primarily in their differing motivation, intent, and odds.
Here’s a look at these important distinctions and advice on how to reliably turn a profit over time.
What the ETF Cheer Squad Gets Wrong About Trading
Like my friend, many people swear by exchange-traded funds (ETFs) over stocks. Nearly every smart financial commentator in the world recommends ETFs and index funds to every (potential) investor who will listen to them.
All the while, nobody is recommending that people devote 40% of their net worth to playing Texas Hold ’em. Why?
Because poker is gambling.
They see ETFs as the safer option—the one that isn’t gambling.
But when someone buys an ETF or index fund, they are not a long-term investor in a company whose cash flows they have modelled and whose valuation they understand. They’re buying a financial asset that they expect to be able to sell at a higher price at some point in the future. Buying index funds and ETFs therefore fits the definition of trading.
My mate calls trading stocks gambling, but billionaire hedge fund managers say the opposite. Who is right? Is trading gambling?
To answer that, we need to understand motivation, intent, and odds.
Motivation, Intent, and Odds
Gamblers and traders, by definition, are not looking for the same results. They have differing motivation and intent
Gamblers want an outsized, lottery-style payoff that they haven’t worked to earn. Something they know they will be lucky to get. Their motivation is the thrill of gambling, their intent is to try to win a prize, and the odds are against them.
If I put USD100 on red at the roulette table, I know I don’t deserve to win. Over time, my odds of winning one spin after a bet of red or black are just 47.37%. Of course, I might win that one time, but I know I can’t win over the long term.
In fact, if I’m playing the long game, it is statistically very probable that I’m going to lose money. And therein lies the thrill of gambling! If I put USD100 on red and win, I’ve done something a bit naughty, something I know I shouldn’t do, but I’ve gotten away with it. I’ve successfully beaten the odds and come out the other side smiling.
As “Fast” Eddie Felson says in “The Color of Money,” “Money won is twice as sweet as money earned.”
Meanwhile, there is nothing thrilling about buying an index fund—or any other “safe” investment. The motivation is the reassurance of a steady income source, the intent is to grow a portfolio over time, and the odds are good.
With ETFs, we know that over a long enough time frame we’re going to win. Nothing naughty or exciting in that. Putting money in a term deposit or a government bond is a yawn-fest. There’s zero chance I’m going to somehow make 100% on my money, but also a (near) zero chance I’m going to lose money, either. I’m going to make 2% on my money and that’s it.
But trading is not passively buying an ETF, and it’s certainly not a term deposit. There are no guarantees in trading. So does that make trading, gambling?
When Buying Shares Is Like Gambling
If I pick a random penny stock to buy, this is gambling.
Again, it’s all about the motivation, intent, and odds. The only reason I’m buying a penny stock is my belief and hope that I'll make a lottery-like return on it. But I can’t predict the odds of my penny stock achieving a 10-bagger return. It might? But it probably won’t. Since my motivation is to take an exciting chance, my intent is to get lucky, and the odds are unknowable, this qualifies as gambling.
What if it’s not a random pick, but rather a careful selection based on research?
First, we need to ask, “What are the odds?” We could look at how many stocks have had similar fundamentals to the stock we like, and how many went on to achieve X% gain within a year. If we can’t answer this, we’re still gambling because we’re hoping to get lucky.
If we do know the answer, then we’re making an informed decision, even an investment decision. If we know our odds and our profit target, we can get out when the investment goes badly, and we can take our profits when it goes well.
How Risky Is Trading?
We know that trading isn’t gambling unless you’re randomly buying stocks, but how risky is it, and can we control the risk?
The first thing a good trader asks herself before she places a trade is “what’s the risk on this trade, and is the potential reward worth the potential risk?”
Once we have selected a high-probability trading setup, the first thing we need to define is our stop-loss. This is our line in the sand—the point at which we are happy to be proven wrong, take a small loss, and move on.
Next, we need to look at our profit targets. Factors like support and resistance, volatility, and momentum all play a part in determining where we are likely to take our profit. If we’re risking 8% on a trade that might only rise 4% before hitting resistance, we won’t have money to place trades (bets) like that for long.
The second question a trader needs to ask is “what can I expect my trading system to do for me over the long term?”
To be a successful trader, your profits over time must exceed your losses. Losses are inevitable, but what matters is that the value of your portfolio grows over time.
Trading Expectancy Determines Growth
The profitability of a trading method over time is determined by expectancy.
Expectancy is calculated as follows: Expectancy = (Probability of a Win * Average Win) – (Probability of a Loss * Average Loss)
For example, assume a trading method produces profitable trades 60% of the time. The average winning trade gains 20% while the average losing trade loses 10%. For a USD10,000 account, the expectancy for this trading method will be: (60% * USD2,000) – (40% * USD1,000) = USD800.
This means, on average (over many trades) each trade will contribute USD800 to the overall profit and loss on the trader’s account—a fantastic outcome. If you can keep the expectancy of your trades positive, you’re trading the right way.
Trade, Don’t Gamble
In summary, trading is gambling only when you’re looking for a quick win, don’t know the odds, and haven’t done your research.
People don’t go to their jobs hoping that today’s the day they’ve won $10 million. They go to their regular jobs knowing that the odds of their job producing a certain amount of income are high, and their goal is to accumulate that income over time.
Successful trading is the same. If we get a handle on our expectancy, grow our value over time, and we aren’t in it for the thrill, we’re trading, not gambling.
The Tao of Trading: How to Build Abundant Wealth in Any Market Condition
In his twenty-five years as a banker, advisor, and player in the markets, Simon Ree has witnessed first-hand the many hurdles individual investors must overcome to succeed. He wrote ‘The Tao of Trading: How to Build Abundant Wealth in Any Market Condition’ to put readers on the fast-track to financial success.
The book teaches readers:
- How to instantly read market trends so you're “sailing with the wind at your back.”
- The most powerful tool in finance for building your wealth AND managing your risk.
- How to generate consistent cash flow from the stock market.
- Simple to learn techniques that will have you trading the markets like a pro.
- And much more.
About the author
Simon Ree has twenty-eight years of experience as an active trader, investor, and financial markets professional. He previously held senior positions with Goldman Sachs in Sydney and Citibank in Singapore before deciding to focus on options trading full-time in 2017. He has spent over 40,000 hours watching and analysing markets, and during this time, he “cracked the code” on how to trade safely and profitably. Today, he’s passionate about teaching others what he’s discovered. In addition to trading, Simon is a certified Jeet Kune Do instructor and a Reiki master. He lives in Singapore.