Investing, Gambling, and Trading (Which are you Doing?)
“Oh, that’s gambling,” my mom said. We were talking about an investment I recommended to her two months earlier. She had followed my recommendation to purchase the security, which closely follows gold prices. It went up. In fact, I checked it while on the call and saw it was up 13.7%. The last time I had a conversation with my mom, it was even higher at 19.2%. Gold then retraced a bit after its strong run. For those that pay attention to these markets, the recent dip was not unexpected. I was happy with the position, mom was confused. “Why didn’t you have me sell it,” she asked?”
I had recommended the security purchase as an investment, not as a trade. The added diversity it brought to my parent’s portfolio, and perceived downside risk was why I suggested it. Those elements hadn’t changed. It still represents a good position relative to all the factors that went into this decision for them. Additionally, in my mind, there is no asset with a more compelling story that I’d replace it with right now, including cash. Especially considering the joint account owners are both in their eighties. As an investment, there is always a risk of loss, but it is not a gamble in the way rolling dice is. I should mention that the position wasn’t put on as a trading play. There have been and will be future transactions (trades) involved, but we weren’t trading this stock, they are invested in it. After all, these are retirement assets.
Today, many people use the terms investing and trading interchangeably. They’re both different activities and gambling is completely separate from each of them. There is a bit of overlap. All three seek to increase wealth. Two try to increase wealth by price movement, these two are investing and trading, they are not the same and require different skills and knowledge.
Investing
Accumulated capital that has been allocated to assets with the intent of growth and producing profit is financial investing. The return on investment is generally expected to come from income or price appreciation. The expectation of a return over time in excess of the initial outlay is key to investments. At times this return will be positive; if the investment goes as expected, the return can, of course, also be negative. Seldom will it be unchanged.
There is risk with investing. This risk is commonly linked with potential rewards and is measured against a time horizon. Using real estate as an example, before purchasing an investment property, the investor may try to determine what the risk is that the property sits unrented, what is the risk of the value declining, what are the risks that cost of ownership increases beyond expected rental income, etc.. Investments in stocks, bonds, and funds have their own sets of risks. The primary investment risk is, “what if the investment is worth less than the cost at the time when I anticipate using the money for non-investment purposes.” Within that risk are all the nuances driving the market up and down, the impact of all the elements affecting the sector, and the time you will hold the investment. There is also the consideration of the universe of other options and which would create the best risk-adjusted return over the expected holding period.
Maximizing return at the end of the holding period should be the primary goal of investors. If they find themselves in the position, as many gold investors just did, where the asset jumps 10-20%, it then deserves to be reevaluated with the question, “Is there now a better place for this capital?” This is the same for investments that are not performing or underperforming. Part of investing is looking at nonperforming and holdings that are underwater and asking if it is still the best place for the capital. Seeking return by evaluating holdings, understanding alternatives to each holding, and working to maximize risk-adjusted return is investing.
Trading
More frequent transactions, such as the buying and selling of stocks, commodities, or even flipping houses, fall under the category of trading. The trader could be using the same vehicles as the investor to attempt to increase wealth. But the decision to buy has a limit in that they are looking for quick short-term moves in the asset. Traders of stock, commodities, and real estate are looking for these faster price moves with a goal of returns that outperform buy-and-hold investing. The skill includes awareness that the money committed is not an investment; it is instead the most important tool to generate income. The “tool” needs to be protected through risk management. A trader without money is no longer a trader; they are out of business. This is one reason a good trader has a time horizon – a bad trade should never become a long-term investment.
High-frequency traders look to earn incrementally over many trades during the course of the day. They have a plan to manage the winners to exceed the losers in dollars they generate. Low-frequency traders may monitor the market for long periods of time before uncovering a setup they believe fits their description of a high probability trade.
Trading can potentially return much more than investing. Deciding when investments are most likely to move, rather than ride ups and downs, is often from a series of calculated speculations which fit a tested methodology of that trader. The trader, like the investor, has to be aware of changes that increase risk without adequate reward adjustment when comparing one trade over another.
Gambling
Wagering, betting or gambling, means risking money on an event that has an uncertain outcome and relies more on chance than does investing or trading. One big difference from investing is that gambling very often has a known outcome probability, both direction, and magnitude. These are called odds (50/50, 1,000,000/1, etc.). There are no firm odds for investors or traders. There could be a history of performance, but no mathematical outcomes that all participants are subject to.
Investors and traders, like the gambler, may also benefit from luck, but when done right, trading and investment decisions are based on expectations that don’t in any way include chance.
Take-Away
Whether you’re investing, gambling, or trading, it is important to have a plan. The plan should involve money management skills. For the investor, they should seek to move into another position when their holdings no-longer offer the best risk-adjusted return expectation. Traders should execute when the trade needs to be entered or exited. Win or lose, money management is key to a trader’s survival. Without capital, there is no trading, that would put them out of business. This can be said of gambling as well. Professional gamblers are able to continue only as long as they have money in which to play their game of choice. The average person that gambles by purchasing a lottery ticket is spending a few bucks, writing off the entry fee almost immediately as they spend it. They’ve purchased a fantasy that can last until they check their success. A raffle ticket, lottery, or spin of the wheel at a Church picnic is viewed as a donation. There are few who view their own gambling as investing and trading. Alternatively, there are many who transact with brokerage accounts acting on hunches and guesses who are leaving too much to chance. Successful investors and traders are more deliberate, more methodical. Hunches are not part of their evaluation.
As an aside, the account my mom spoke to me about is an investment account. She is going to hold onto her gold position until something else makes more sense to replace it. She is not a trader. However, her gambling luck is top-notch. Last year she won a $50,000 Mercedes in a Church raffle. Perhaps her exclaiming “that’s gambling” was intended as a positive.
Paul Hoffman
Managing Editor, Channelchek
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