All In: A Comparison between the Gambling and the Investment Business
According to a popular saying, gambling in a casino is the same thing as investing in the stock market. Most probably you have heard this saying already hundreds of times, but is it really true? Letís analyze both activities. You will find major differences but also surprising accordance.
The most obvious similarity is that both have strong elements of risk and choice. In both cases, the player either on the gambling table or at the stock market has to make an exact decision on how much money he is willing to risk. Stock traders usually invest between 2% and 5% of their money in one trade. Long-term investors tend to scatter their investments in different asset classes, which is basically nothing more than an applied risk management strategy. It will certainly help to lower all potential loses to an absolute minimum.
Gamblers have to make in principle the same decision, since they have to decide carefully how much money they are willing to risk. But in this case, it is the pot odds which regulate the amount to be invested. The pot odds tell the player how much money he can invest to call a bet and they always depend on the actual pot size. If the odds favour your hand, you will more likely call the bet. Almost every successful player uses such an efficient risk management system. Therefore, the key principle in investing and gambling is to maximize the profit for a minimal risk.
Investing real money
The most common form of gambling is sports betting. Almost everyone participated in sports betting once in their lives. It is an old American tradition to bet on all sports event starting from the weekly football games up to the Final Four. However, the sportsí betting does not provide any way to limit your losses. If you place your money (e.g. $10) on a certain NFL team and the team loses, all your money is gone. You have a loss of 100%. Almost none of sports betting or other pure gambling activities have a loss-mitigation strategy.
In contrast to gamblers, stock investors and traders have more opportunities to prevent losing all the invested money. The most widely known and used method is to place stop losses on the stock investment. With a stop at 10% below the purchase price you guarantee, that you will keep at least 90% of your investment. If you place a bet on the Jacksonville Jaguars to win the Superbowl, being at the Superbowl game is not enough. Either they make it, or you lose. Since sport betting is completely speculative, you can hardly use it to minimize your losses.
The second important difference between investing and gambling is the time scale. Gambling is by definition a time-bound event while an investment in company can stay for years. During a poker game, you have to decide for each hand and whether you will make an investment or not. Your opportunity lasts exactly for the duration of each particular hand. However, the investment in a company is generally a long-term decision. By an investment in a company that pays dividends and holding their stocks, you can get actually some of your risked money back. According to most experts, dividends are the key to a successful investment in stock markets.
Using the odds in your favour
In order to increase their profit, stock investors and gamblers are looking for an edge. In certain ways, both learn from each other and successful players of both groups are using somehow similar strategies. A poker player tries to get the information from the other players at the table. A great player can remember the amount of chips his opponents wagered 20 hands ago. He uses in addition the combination of the manners and the betting patterns in order to guess their hands. Predicting the cards of an opponent is very useful since it raises your own chances. In the same way, stock traders try to interpret stock charts and news according to different companies. There are even stock market technicians who try to predict the future development of a stock with respect to its behaviour in the past. The techniques of studying and analyzing stock chart is usually called technical analysis.
A major difference between stock market and gambling is the availability of information. For both sectors, the information is very valuable. For companies there are strict rules what information has to be announced officially. Before you invest your money, you can study the company earnings, financial ratios and information about the management teams. Professional stock traders use the daily news to make their future investment profitable. However, the information provided by the companies may not always be correct or announced correctly. This is the reason why insider trading and the Security and Exchange Commission (SEC) still exist.
The situation changes completely at a gambling table in a casino in Las Vegas. You will not have any information what happened at this particular table some hours, days or weeks ago. You might hear about a table that is so called hot or cold but this is not a quantifiable variable.
If somebody tells you the next time, that stock investments and gambling is the same thing, you can show him the similarities and the big differences. Both depend on risk capital that must be invested in order to get future profit. But gambling usually takes place on a very short time-scale while stock investment can take a lifetime, especially when the company pays dividends to their investors. In general, for an average investor the better investment over a lifetime is the stock market , not the try to win the World Series of Poker.