Are trading and gambling the same?

This blog first appeared in the DanCollinsReport on July 16, 2013.

Trading and gambling are similar in that they both attempt to create a capital gain, over a relatively short period of time, without creating new wealth. If I am a shoemaker, then my efforts create a pair of shoes that someone else can wear (new wealth), while I earn an income from cobbling. When I am a trader or gambler, I may earn an income, but there is no additional wealth created. Some markets experts would claim traders create market liquidity to the benefit of long-term investors, and that this in itself has value, similar to “new wealth” creation. But because trading and gambling involve capital transfer without capital creation they are viewed skeptically, especially when their outcomes are unpredictable. Society generally prefers the shoemaker-type endeavor because it creates something others find valuable.

Trading and gambling are both fundamentally stochastic, that is unpredictable, and because of this they are often viewed negatively. We feel an “honest effort” has more predictability to it, and we may hold those who take too much risk in disdain. However, many who have tried their hand at a new business will attest to significant luck when successful. The goal of new wealth creation, and the time needed to develop a successful business, act to mitigate the risks involved. But then, traders and gamblers will often describe many years of practice before becoming successful.

Trading and gambling both occur because, at least at their start, the participants have accrued wealth in excess of what they need to live. This is similar to the investor who possesses excess capital (and typically much more than the average trader or gambler). Investing has a connotation preferable to trading because the investor is viewed as enabling new wealth creation and because it involves delayed gratification – the benefits of a sound investment may take many years to realize – just those attributes described above. There seems to be an inherent respect for a long-term investment that turns out well: The successful investor is considered patient and prescient. On the other hand, trading and gambling have a get-rich-quick aura to them and are often viewed with disdain because of it. In fact, a professional trader or gambler may not get rich quickly, but simply earn income slowly over time.

When modern civilization enabled some individuals to amass wealth in excess to what was needed immediately to survive, speculative trading and gambling naturally evolved, and traders and gamblers may be viewed negatively because they are using money that others do not have. Because no one has yet determined an equitable means of evenly distributing wealth, trading and gambling should not be considered inherently evil. No one objects to an employee retirement fund investing in the stock market: The capital has been amassed and must be somehow managed.

Successful traders and gamblers are typically highly skilled and spend years becoming proficient. Success often means a steady regular income and not a one-time jackpot event. Because society values most activities that require a highly-developed skill, the successful trader or gambler will be viewed in a positive light, while the failed participant is merely seen as one more “loser.”

Both trading and gambling have seen the development of numerous mathematical (and pseudo-mathematical) techniques in order to increase their chances of success. Because the mathematics of trading and gambling can be made precise and add to our understanding of natural events, there is new wealth creation from those who have contributed to defining profitable trading and gambling techniques. Often these individuals are held in esteem while the practitioners of the techniques are not. For example, the Nobel Economics Prize was awarded to the inventors of the Black-Scholes options pricing model, while those who daily use the model’s outputs are viewed merely as traders.

So much for a broad-brush outline of the similarities of trading and gambling; what of their differences?

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