Trading & Gambling

Trading & Gambling.

A lot of people say ....trading is a gambling and a lot gamblers ultimately lose money.
So is the trading gambling??. Or maybe should we ask "who are the consistent winners in gambling"...

In gambling the consistent winners over the long term are the casinos. So is it possible in trading to operate like a casino and be a consistent winner? To understand how casinos win consistently, you first have to understand the concept of Expectancy which is defined as follows:

Expectancy = (Probability of a win X Actual Gain) minus (Probability of a loss X Actual Loss).
Let's take the game of Roulette where there are 36 numbers for you to bet on.
If you bet $1 on any particular number and win, the casino will pay you $2. If you lose, you lose your $1. The variables are as follows:

Probability of a win = 1/36, Actual Gain = $2 (the casino pays you $2 if you win)
Probability of a loss = 35/36 Actual Loss = $1 (you lose your $1 if you bet the wrong number)

Plug the numbers into the above formula for Expectancy and you get minus 0.92. This means in the game of roulette, the expectancy is "negative" to the gambler. If you play a game with negative expectancy you will eventually lose all your money. Another way to think of expectancy is whoever has positive expectancy in a game has the "edge". In the case of roulette, the casino has positive expectancy and has the "edge" over the gamblers.

Ever wonder why casinos give gamblers free meals, free hotel rooms, and air tickets? Apart from attracting gamblers, they want gamblers to stay as long as possible because when gamblers play a game with negative expectancy, it's a mathematical certainty that they will "eventually" lose all their money if they play long enough. How else do you think Stanley Ho and Steve Wynn made their billions?

So in trading, how do you structure yourself to think and act like a casino? Few suggestions below.

1. Every game in the casino has clearly defined rules on how it is played. So in trading, you must have clearly defined rules governing entry, stop loss, exit, and position sizing - a trading methodology. You simply do not make bets in trading based on your whims. And over many trades your trading methodology must have "positive" expectancy (there is a way to measure this).

2. You have to size your bets appropriately so that no series of losing trades will take you out of the game. The casino doesn't bet the house on a single bet. Rather it has enough working capital to weather the "inevitable" losing streak. The same in trading.

3. The casino take every single bet from gamblers and doesn't try to choose and pick its bets. While the casino may lose on individual bets but over many bets, the odds of positive expectancy plays out to the casino favor, i.e. they make a net overall profit. Likewise, in trading you have got to take every single trade signal of your trading methodology and not attempt to pick your trades (it simply cannot be done). Most losing traders spend their entire life trying to predict markets and avoid losses.

4. Be totally disciplined and consistent. The casino stick to the rules and doesn't change the way it plays the game irrespective of whether they just have 10 winning bets in a row. In contrast, most traders start to get carried away when they have a series of winning trades. They start to bet bigger and deviate from their rules and they eventually blowout (think Long Term Capital Management).

There are old traders and there are bold traders but there are very few old and bold traders. - Ed Seykota.

It takes 3-5 years (and sometimes longer) to acquire the above "basic" trading skills. During this period you make no money and frequently lose money. This initial "starving phase" is most difficult and mentally damaging to go through.

That's why 95% of people who attempt trading don't make it. But the payoff is well worth it for those with the determination to go through it.

So to sum it up, trading is gambling. But in trading, just like in gambling, you can be a consistent winner by being the house.

 

You need to re-work the numbers.
There's 37 numbers on the wheel, you forgot the dreaded 00 (green).
If you bet $1 on a number the casino will pay you $35 if the ball lands on it.

You will still end up with a -ve expectancy however not as dramatic as you've stated.

 

Oops...
I am not a gambler. Are you a Roulette player ??

 

Can't affort to be a player, just have an interest in statistics.

 

Tropo,

Thanks for your post - makes really good reading.

One comment about the quote above. Having never tried trading for real I find this hard to understand. What are the 'basic' skills you are referring to?

I'm assuming it is not the technical skills (eg, developing a system with positive expectancy, understanding and applying sensible position sizing, etc). Assuming I can develop a system with (significant) positive expectancy and I understand money management and position sizing what is it that takes so long to develop?

John.

 

John,
Technical skill is important because you need tools to trade.
The most important part is psychology of trading. And belive me, this is the hardest part to master. Trading is not the game of luck or chance. Trading is about method you may develop having confidence in and stick to it no matter what. One of the fears face many traders (me included in the past) is to pull the trigger without hesitation when system is giving you signal to buy or sell.
Time to learn trading skill vary. Some people need few years and some will never learn. Common case is to blame everything and everybody incl. neighbor's dog if things go wrong. It takes time to understand that YOU are the only one to blame for mistakes. It takes time to correct bad habits and change your own mentality.
If you would like to know more about trading psychology, I would recommend you Dr. Alexander Elder's book "Trading For A Living". Dr Elders is a psychiatrist who works with traders. Very interesting reading....

 

very philospoical post...

i like it... dont we all wish we were casinos....

 

The casino in the trading world is the broker. Everytime you trade, they're making money and loving it.

BR

 

Nassim Taleb who is a funny guy worth reading thinks comparisons between casinos and the markets are comparing two different things due to the predictable distribution of results. Basically casinos deal in a vanilla very rigid distribution of results which is not the randomness you deal with in the markets.

Your expectancy is always changing with trading, something that doesn't happen at the roulette wheel.

A few basic things to track. Easy to do in Excel, if you start with basic understanding of risk control which can be something as simple as understanding position sizing and fixed % money management then I think you have taken a huge step in the right direction.

Profit $
Trades
Total Trade Length
Average Trade Length
Wins
Losses
Scratches
%Wins
%Losses
Average Profit
Average Win
Average Loss
Win/Loss Ratio
Maximum Win
Maximum Loss
Expectancy
Profit Factor
Average R Return
Max Draw Down