It all depends on your definition of gambling, but poker is a poor analogy as others have noted. But the elements of risk and reward remain the same for most people who trade financial instruments. The exceptions are the brokers. Unlike a casino which simply wins more than it loses, the financial industry is rigged to always win. To quote a former Bear Stearns broker, ‘if it matters to you whether the price of the stock goes up or down, you are playing the wrong game’.
Interestingly a combination of interests has conspired to convince people that derivatives are very complex and difficult to explain. In fact they are simple wagers between parties. If X occurs, party A pays an amount to party B. X may be a very complicated set of circumstances, but the concept is simple. It is no different than two people betting on the outcome of a football game. Since there is no consideration in the transaction, it is purely gambling.
There is risk in any investment so maybe we need to quantify at what point risk becomes tantamount to gambling. That’s not a call I’m prepared to make.
That being said, there are critical differences between Buffet and the guy sitting in front of a half dozen monitors, racking up scores of trades (and commissions) each day to come away with the financial market equivalent of a teddy bear and a lolly pop.
No one ever REALLY knows if a stock is undervalued except people with privileged knowledge (which at least in theory, they aren’t supposed to trade on). Buffet researches his targets so thoroughly and has access to the kind of information that makes him a virtual insider. For example, he can find out that assets being carried on the balance sheet at their depreciated value might in fact be worth double that. Maybe that isn’t the best example, but the point is that he will have information that is not readily available to you and me from reading SEC filings or listening to conference calls. That information, while not eliminating the risk of loss, does serve to decrease it substantially.
Another advantage he has is the relative illiquidity of his investments. If you are looking to sell Burlington Northern, there aren’t a lot of people who are in a position to buy. That gives you a lot of leverage. Did you see the deal he made with Goldman Sachs at the height of the financial crisis? That’s a perfect example of what I’m talking about.
I’m seeing a lot of people claiming that day trading can be positive-expectation, and supporting that claim by giving examples of positive-expectation investments. But day trading is not investment. Sure, the general trend of the market is up, but the amount of that trend you’ll see in a few hours or minutes isn’t anywhere near as much as the brokerage fees you’ll pay. The day trader is not the house; the house is the brokerage firm.
And if it were possible to actually come up with a strategy that would let you beat the market, then the brokerage firms themselves would find out what that strategy was, and create automated programs to arbitrage those strategies until they didn’t work any more. In other words, if your strategy ever did work, it doesn’t now.
Does this mean it’s impossible to make big money by day trading? Of course not: It’s possible to make big money on any sort of gambling, and a few folks do. But most folks will lose money.
Not at all. It’s something that my friend mentioned up thread occasionally struggles with.
To answer a mishmash of comments and questions from upthread, I think that he holds stuff for a day or two typically. Sometimes longer. Not usually for just a few hours. He makes thousands of trades a year. His tax return is the thickness of a small textbook documenting all of those trades.
He’s been doing this for many years and hasn’t had a real job in all of this time and has a lot to show for it so I know he does well at it. There are time when the market conditions aren’t right for him and he will just sit out and not make any trades for a while.
Hugh fund managers aren’t comparable. They have strict rules that they have to follow that partially handcuff them. A tech fund has to stay in tech even if tech is a bad bet today. They have an unwieldy amount of money and can’t move as fast plus can’t have too large of a percentage in any one thing no matter how undervalued it might be. No comparison.
It’s actually a negative-sum game when you take into account fees (plus other overhead when you are trying to make a living at daytrading.) So it’s possible that even most skilled people will break even even if most small amateurs lose money. Of course, the hard facts tell us that there are people who do make a living day trading, the only question is how difficult it is.
I think a lot of people have an image of day traders as a bunch of guys sitting in their moms’ basement in their underwear randomly buying and selling Pets.com. Professional trading firms are quite sophisicated in terms of their technology and intellectual capital. People say, “If something worked, an efficient market would eliminate the profit potential.” Professional traders are the guys that do that.
That’s a good point. I use them for comparison because they invest for a living and have access to more and better information. Being free of any limitations on what and how you trade has it’s advantages. Maybe hedge funds would be a better comparison. I can’t recall seeing any statistics on how well they do over all, but my guess would be that on average, they aren’t any better - it’s just that the gains AND losses will be more spectacular.
Yes. It’s more than just coming out positive with the trades. You have to pay tax (short term capital gains) on your yearly net earnings. Fees and office expenses are deductible but you still have to pay them. Very few people can do this enough to make a living.
In this way it is compatible to poker. You not only have to be better than the other players, you have to overcome the rake which is the ~5% that the house takes out of each pot. I have heard a few times that only 10% of poker players come out ahead over the long term and way fewer can live off of their poker earnings. I played a lot of poker in casinos and card rooms for a few years and kept a spread sheet of all of my play. I was one of the 10% who was in the positive over hundreds of hours of poker. Unfortunately, my hourly rate was like $1.20 so I stuck with engineering.
I think that **dracoi **made the point that I wanted to make, first in this thread. I would call a play *gambling *if it was zero-sum or worse; if in order to win, someone else had to lose. I would call a play *investment *if it was a purchase of a productive asset, so that it could return a profit even if no-one else lost anything.
Thus, buying seed for a field is an investment, and playing poker is gambling. It is possible to make a living at poker, but for every one person who does, a lot of others have to lose money.
Day trading as practiced by individuals is pretty clearly gambling, because they have no intention of holding the assets long enough to realize any production. Day-trading by large firms might be a different situation.
By analyzing how the market responds to price swings without caring too much about WHY the price is moving.
Real Example: the “dead cat bounce”…When a stock suddenly drops by a huge percentage of it’s former value, especially if it is to the point of not being able to go much lower, it not infrequently rebounds a bit due to bargain hunting. If you can be one of those first bargain hunters, then you can often make a fair profit in a short time period. If the price is beat way down, then even a modest rebound may be a large percentage increase over the low point.
I know one day trader who would start his trading day by looking at the biggest losers the day before, and picking a few for the “dead cat bounce” play. He made a lot more than he lost on those. Beyond that he had some blue chip tech stocks that he would buy and sell maybe twice a week when the market made a big swing one way or the other.
A lot of it is along the lines of looking for areas where news or perceptions can affect certain stocks and how investors typically react to it.
If you drop you money into a stock prior to an earnings announcement how will the market react? Even if earnings are down, a firm might guide higher for next year or mention that a new product still sold better than expected. That could take the price higher. Day traders aren’t betting one way or the other on what the earnings are. They are looking for price patterns to see if the herd is betting up or down and then follow them in. And they believe that the trade patterns are consistent enough to make a few nickels on each share. Day traders even have cute little names for certain types of patterns. In the end you are hoping that humans and trading programs will behave in a certain way. Often they do, but often they do not.
I had a friend who did it for a while and got burned. His biggest problem was in psychology. If he bet wrong, he stayed in a loser just that little bit longer than he should have. Mainly because he hated taking a huge loss and thought that he could recover just a little. Fatal mistake, not unlike the gambler who plays a bad hand too far or doubles down hoping to get some money back. It does take nerves of steel to be able to check out of a position with a six figure (or more) loss.
I don’t think it’s as random as gambling. People do tend to follow the herd and they do tend to overreact to various types of news. But it’s one thing to bet on people acting stupidly, it’s another to be able to bet on how the stupidity manifests itself. But the big winners are most likely the people selling trading software and courses and the brokers executing the trades.
Not my cup of tea but not a great boil on society’s backside. Lots of people do quite well at it, lots get beaten up and quit.
Here’s what I think you’re missing: there’s a huge difference between “losing a fortune” and “beating the index.” To me, losing a fortune means starting with $1 million and ending with $100,000 or something like that.
In my example, though, the day trader had a return of 3.5% for the year. He made money. He even beat inflation.
However, the index would have been somewhere around 8-12% for that year.
So the day trader “lost” in the sense that his assets did not perform as well as they should have - he failed to beat the market. He could have had a higher return with 0 risk by putting it into a CD at 4.5%
(PS: For what it’s worth, I’m very familiar with the research behind the bank rate article. Everything I own in the market - except for Apple stock and AIG bonds - is in index funds. I’m a true believer that index funds are better than money managers over the long term.)