Is stock trading the same as gambling?

Why Trading Stocks is Not Gambling

Ed Seykota once said, “Win or lose, everybody gets what they want out of the market.” Ed is a legendary trader featured in the Market Wizards book series.

If someone wants to gamble in the markets, they certainly can. The market lets you. But if you want to develop a rigorously tested method that produces profits month after month, the market lets you do that, too. You get out of the market what you want, and results are based on the effort put in. So how is trading different from gambling?

A key difference is expectancy. Expectancy is how much we can expect to make for each bet placed. Traders can develop systems with a positive expectancy, meaning you win more than you lose over the course of your many trades.

With trading, you can either win more often than you lose, or you can win bigger amounts of money than you lose. In either case, your wins total more than your losses.

With gambling, there is a negative expectancy. The more bets you place in a casino, the more likely you are to keep losing money. In this case, the casino has a positive expectancy, say 51% per hand, and you have a negative expectancy.

On a slot machine, you could have a huge payout for a small bet, but the odds of winning a big payout mean you are likely to run out of money before the big payout comes. The lottery is also like this. Big payout, but near zero odds of winning. It’s gambling because your expectancy is below your investment amount when you multiply the odds of winning by the payout.

Gambling can also involve a game of chance. If you buy a stock with no knowledge of what you are doing, that stock price will either go up, down, or do nothing. Your outcome is random. This is a form of gambling.

But, if you research chart patterns and share prices, for example, and study hundreds of them, you may find that the price moves in a specific direction following the pattern 60% of the time. If you trade this pattern, your results are no longer random; you know that on average the price will move in your favor 60% of the time.

Gambling in trading is when you don’t know the odds, or when the odds are against you but you continue to trade. These are common trading mistakes to avoid. Successful trading is knowing the odds, and only trading when the odds are in your favor.

So how do you put the odds in your favor?

How to Not Gamble on Your Stock Trades

You now know the difference between what successful traders do and what gamblers do. Successful traders put the odds in their favor — but how?

If you don’t want to gamble on your stock trades, you’ll need to do some research and study. One of the simplest strategies for trading stocks is to buy-and-hold index exchange-traded funds (ETFs). ETFs trade on stock exchanges and can be bought and sold like shares.

ETFs track an index, and some indexes have been around for a long time. Tracking various US market indices going back 150 years, the average yearly return is 9.079%. Over the last 100 years, it is 10.331% per year.

That is probably the simplest way to invest in shares without gambling. The index is actually a strategy, where the curator of the index only includes certain stocks that meet specific standards of quality. The indices go up and down, and in some years the value drops, but over the long term the indices have risen close to 10% per year on average.

That is a baseline. For doing almost nothing except buying and holding index ETFs, it is possible to make approximately 10% per year over the next 15, 30, or 45 years. If you want to make more than that, you will need to put in more work and research into finding methods that can beat 10% per year.

Trading more often, if you have an edge, can produce higher returns. Examples of this include day trading and swing trading. You can lock in gains quicker, avoid periods that don’t suit your strategy, and compound money with each winning trade.

Most professional traders develop their own trading strategy for profiting from the markets. While they learn from others, ultimately they must dig into the charts and see which factors and conditions tend to produce profits more than losses.

They come up with a strategy idea (entry and exit method) and test it by adding up all the profits and losses the strategy idea would have produced over the last 50 or 100 trades. This is done using historical price charts.

This provides a good baseline for whether an investment strategy is viable or not. If it produces a profit over the last 100 trades, then the trader can start using the strategy either in a demo account to further test it out, or in live trading. They continue to refine the method, attempting to make it more profitable as they gain more experience trading the strategy.

Unless you plan to simply buy and hold index funds, trading and making higher returns will require digging into this type of research. That involves scrutinizing charts and other people’s (or your own) strategy ideas and seeing what works for you and what doesn’t. This goes for any market, such as forex, futures, or options, not just stocks.