How many of us have spent some time in Las Vegas to try our luck? Most of us probably know enough not to overdo it, making sure that we only bring along the amount of money that we are okay with losing. Why? Because odds are, we won’t be coming home with the same amount of money we left with. If you’re one of the lucky few, you’ll come out ahead. But most of us will come home a few bucks lighter than we started out.
First time investors often find themselves wondering what the difference is between straight up gambling and investing in the stock market. Let’s start with the dictionary to get some clarifications. Merriam Webster defines gambling in two ways:
1. Playing a game for profit (money or property)
2. Betting on an uncertain outcome
Isn’t this the same definition most of us can apply to investing — the idea here that we put something out there in order to make a financial gain? And aren’t we really trying to predict the future? I think that most of us would like to think that investing involves more than just a little luck when it comes down to making some cash, but I wonder just how many people are investing on just a wing and a prayer to Lady Luck?
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Investing vs Gambling: Are You An Investor, Trader or Gambler?
In order to understand the difference between a true investing strategy and simple gambling, let’s take a quick look at some of the different players (or types of wayward “investors”):
Socially Motivated Investors: Following The Herd
These are the folks that dive into investing because everyone else is doing it. These are the same people who would jump off the bridge, after someone else who’s done so. Well, okay, I’m exaggerating here, but you know what I mean. These are the very same people who buy the LCD big screen, purchase the Lexus, and install the swimming pool just because Mr. Jones across the street did. Such a person typically knows absolutely nothing about the market or even basic investing for beginners and is, in every definition of the word, a gambler. He would rather take a gamble with his cash than to look bad in front of his peers. The good news is that these guys are the masters of imitation. They tend to hide their lack of knowledge behind the investment strategies of their peers, which might actually work out for them — at least, if their peers are investment savvy. I guess the question here is whether we are simply following the actions of the herd, or whether we are actually thinking independently and basing our decisions on our own requirements and risk profiles.
Adrenaline Junkies: Chasing The High
These are the people who get into investing simply for the thrill of the chase. They live off the highs and slog through the lows, chasing returns. There is rarely, if any, discipline, analysis or strategy that direct their investing, as they choose instead to buy or sell on a whim or use some hot tip heard on a forum or television show. These guys might actually be some of the riskiest investors/gamblers out there as there is absolutely no rhyme or reason to their investments whatsoever. At least, socially motivated investors attempt to mimic what other investors are doing, but adrenaline junkies are too erratic to be considered investors at all.
I recall the investment period known as the dot com era, when everyone and their brother invested in the stock market. While a lot of folks then were simply following the herd, others were performing stock trades, chasing higher and higher prices. They were following the momentum, which at that time, was consistently on an uptrend. As these investors and traders found themselves minting money hand over fist, they got increasingly bolder about the risks they were taking and the moves they were making. I found myself arguing with many such “investors” about the risks they were taking in the market, but they pooh-poohed my concerns — they were addicted to the market and couldn’t accept that anything could go wrong. Unfortunately, they were the same people who found themselves losing their shirts when the dot com bubble burst.
Emotional Investors: Deciding With The Heart
There are people who are hybrids, displaying the characteristics of both investors and gamblers. They are armed with just enough knowledge to be dangerous. Most successful investors know that the key to success is to master a few good strategies and to be committed to executing those strategies, no matter what. But some folks are emotional investors: they know a little bit about a lot of strategies and decide that the best way to make money is to switch strategies in mid trade. The other aspect of this type of investor is that in many cases, they fail to admit when they are wrong. They hold on to bad investments hoping for a turnaround instead of understanding that sometimes, a loss is a loss and that good investors are sometimes wrong. Holding bad investments for too long turns what could have been a savvy investor into a gambler (in this case, one that ignores all signs that a position is a bad one, and who would therefore take the gamble that things will recover at some point).
The bottom line here is that in order to be a successful, rational investor, we should learn how to stamp down our natural gambling tendencies and invest with our heads and not our hearts. We have to understand what it is we are investing in and how we are approaching the investment. The approaches we take have to be methodical and disciplined. Thus, we should be able to admit when we’re wrong, and to cut our losses when it makes sense to.
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