Are Digital Options Gambling Or Investing You Decide

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Contents

What is the Difference Between Gambling and Investing?

“It is generally agreed that casinos should, in the public interest, be inaccessible and expensive. And perhaps the same is true of stock exchanges.”

you may surprise yourself. (Go ahead, I’ll wait here for you.)

What definitions did you come up with? Are investing and gambling mutually exclusive, or is there an area of overlap? And are the boundaries clearly delineated, or is there a gray area in the middle?

Let’s see what the dictionary says. Here’s what the Random House dictionary on my bookshelf says:

  • Gamble: “To play at any game of chance for stakes. To stake or risk money, or anything of value, on the outcome of something involving chance.”
  • Invest: “To put money to use, by purchase or expenditure, in something offering profitable returns.”

Both seem reasonable upon cursory review, but a closer look reveals that they’re not terribly helpful. The definition for gambling could apply just as well to investing, and vice-versa.

The Dictionary.com web site says:

  • Gamble: “To bet on an uncertain outcome, as of a contest. To take a risk in the hope of gaining an advantage or a benefit.”
  • Invest: “To commit money or capital in order to gain a financial return.”

Again, the distinction isn’t clear. In investing, are you not betting on an uncertain outcome? Are you not taking a risk in the hope of gaining an advantage or benefit? In gambling, are you not committing money? Are you not doing it in order to gain a financial return?

Beyond the Dictionary

Investing is a good thing, gambling is a bad thing.

I think it would be hard to argue with the claim that investing is, on the balance, a good thing. Investing is widely regarded as the engine that drives capitalism. It tends to put money in the hands of those with the most promising and productive uses for it, and drives the economy gradually upward. Investors aren’t merely betting on which companies will succeed, they’re providing the capital those companies need to accomplish their goals. The U.S.’s leadership position in technology is largely due to investments by venture capital firms, angel investors and technophilic individual investors. Similarly, you can change the world in a small way by investing in companies you believe in, such as socially or environmentally conscious firms and mutual funds, or biotech companies that are working on diseases that might affect you or someone close to you.

Gambling, on the other hand, is not so clearly making a positive contribution. Gambling does tend to help local economies, but also usually brings with it well-documented unpleasant side effects. I’ll leave it up to the reader to decide whether gambling is, on the balance, a plus or a minus. Looking to the financial markets, one could make the case that people who gamble in this realm do serve a function, by adding to the market’s depth, liquidity, transparency, and efficiency. But that’s of relatively minor value, and those gamblers probably capture most of that value for themselves. On the other hand, they often increase the volatility of the markets, which is on the balance usually a negative (although it does afford savvy investors opportunities for larger profits). As Warren Buffett has said,

“Wall Street likes to characterize the proliferation of frenzied financial games as a sophisticated, prosocial activity, facilitating the fine-tuning of a complex economy. But the truth is otherwise: Short-term transactions frequently act as an invisible foot, kicking society in the shins.”

The questions of whether gambling is morally wrong and how strictly it should be regulated are important but are well beyond the scope of this essay, and so I’ll mention them only in passing. Governments generally frown on gambling (unless, of course, they’re getting the lion’s share of the profits, such as with state lotteries). Many religions frown on gambling (but they don’t seem to mind church bingo). I have no problem with a person being morally opposed to gambling, as long as that person knows exactly what he/she means by ‘gambling’.

I should hasten to add that not all types of investing are productive. Buying and holding results in a positive contribution to the economy, but buying and selling quickly, the way day traders do, results in no net contribution. For the purposes of the current investigation, we could either reclassify investing-type activities that aren’t productive as gambling, or we could consider these to be exceptions to the rule. I lean toward the latter interpretation.

In investing, the odds are in your favor; in gambling, the odds are against you.

“An investment is simply a gamble in which you’ve managed to tilt the odds in your favor.”

But that position is too simplistic. There are plenty of investments where the odds are against you: futures, options, and commodities trading (where you get hurt on commissions and the bid/ask spread), frequent stock trading (for the same reason), and selling short (since the market goes up rather than down in the long run), to name just a few examples. Similarly, while for most types of gambling the odds are against you, it is possible for the odds to be in your favor. I spent one summer during college working in Arizona, and I drove up to Nevada most weekends to play blackjack. By counting cards, I was able to obtain a small but predictable advantage over the house, about 1.5% per betting unit on average. (I haven’t returned since then, for several reasons: it’s not intellectually challenging; while card counting is not illegal, Vegas casinos can make you leave if they suspect you of doing it; and I’ve found it easier and more enjoyable to make money in stocks than in blackjack.) Expert poker players can also make money at casinos, because their competition is other players rather than the house, and as long as the house takes its cut it doesn’t care how the rest of the money is redistributed among the players.

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There are additional problems with this attempted characterization of gambling as a losing bet and investing as a winning bet. It implies that a given activity switches from gambling to investing (or vice versa) as soon as the odds swing past the breakeven point. Similarly, if two players are participating in an activity in which one has an advantage over the other, it would mean that one person is gambling and the other is investing. That would imply that institutions which get in on IPOs at the offering price would be investors, and the little folks that those institutions immediately flip the shares to for a profit would be gamblers. Furthermore, while it’s possible to calculate exact odds for some casino games, this is rarely the case on Wall Street. How can you know for sure whether the odds are for or against you if you decide to buy a particular stock today?

What about venture capital investments, you say? Aren’t the odds stacked against them? Yes, the majority of venture capital investments result in loss, often a total loss of the amount invested. However, venture funds typically yield higher returns than stocks because a small percentage of the firm’s investments are home runs, more than making up for complete losses on other investments. So while venture capital might seem like gambling in that the odds are against the VC firms on any given bet, on average the expected payoff is positive, so the odds in the long run are actually in their favor.

Gambling can be addictive and destructive, but investing can’t.

“We don’t know the true extent of the problem because hardly anyone identifies it as a gambling problem — they see it as a ‘financial problem’ or an ‘investing problem.’ “

Gambling is entertainment, investing is business.

“Global financial markets represent the greatest spectator sport humanity has ever devised. It has planetary reach, a multitude of local competitive arenas, volumes of statistics, star players, and — best of all — anyone can move between the domains of observer and participant, fan and player. If you squint just right, the steadfast newscasters of CNBC appear to be play-by-play announcers, calling the game for U.S. fans. And do financial sections of newspapers differ from sports sections in their presentation of story, data, and personality? Not essentially.”

While the ‘gambling as entertainment, investing as business’ dichotomy may have been clear in the past, the line is being blurred. The internet has enabled online brokerages and other financial web sites to revolutionize retail investing, which on the balance is a tremendous benefit to both individual investors and the economy in general. However, the widespread accessibility of cheap online trades has also attracted some people who enjoy betting and view online trading as a new form of entertainment. The major factors accelerating this trend are that gambling is strictly regulated and not ubiquitous, and that the odds are usually better in investing than in gambling.

Chris Anderson, executive director of the Illinois Council on Problem and Compulsive Gambling, has said that compulsive gambling isn’t really about making money, it’s about “action”, and the lure of the big win. While I’m not a neuroscientist, I suspect that the chemical changes that occur in the brains of compulsive gamblers and compulsive day traders are similar, since they’re both riding on the same emotional roller coaster of wins and losses. Similarly, while some people who invest in high-tech stocks do it for the potential returns, others do it because of the rush they get from the tremendous volatility. It feels right to classify the latter group as gamblers rather than investors.

I don’t mean to imply that I think it’s acceptable to gamble for entertainment but not to invest for entertainment. I think both are equally acceptable, provided the person enjoys the activity (as opposed to feeling a compulsion to participate) and provided the person uses only money he/she can afford to lose. But I’m probably not the best person to make a judgment on this question, because I’ve never found either gambling or investing to be entertaining. my goal has always been value creation rather than enjoyment, and I place bets only where the odds are most heavily in my favor, not where I expect to find the most excitement.

Investing is saving for specific goals, such as retirement, while gambling isn’t.

Investors are risk-averse, while gamblers are risk-seekers.

Risk-taking is intrinsic to both gambling and investing. There are a few investments that don’t entail risk, such as fixed annuities and government bonds held to maturity, but even those have inflation risk. The major difference between the two groups seems to be the participant’s relative willingness to accept risk. Investors tend to avoid risk unless adequately compensated for taking it, but gamblers don’t. To put it another way, investors take only the risks they should take, while gamblers also take some risks they shouldn’t take. Would you rather have $50 or a 50/50 chance at $100? If you take the $50, you’re an investor. If you go for all or nothing, you’re a gambler. Would you rather put your money under your mattress or in an extremely volatile stock that could go bankrupt or could double in value? The question is slightly different, but the answer is equally instructive. If you expect to double your money quickly, whatever you’re doing is probably gambling, even if it happens on Wall Street rather than in Las Vegas.

However, this characterization of gamblers as risk-takers applies only to non-professional gamblers, people who visit Atlantic City for a weekend for entertainment purposes. Professional gamblers who have managed to tip the odds in their favor behave more like investors, shying away from risk unless the reward is sufficient to justify taking the chance. In fact, one could make the argument that investors generally take on more risk than professional gamblers, because of the uncertainly inherent in the financial markets. As I mentioned before, it’s difficult for investors to calculate how much of an advantage they have, but the odds of a given gambling strategy can be known either precisely or at least approximately.

Investing is a continuous process; gambling is an immediate event or series of events.

Investing is the ownership of something tangible; gambling isn’t.

The latter half of the statement is certainly true, but the former half is only sometimes true. Some investments involve the ownership of something tangible, but many don’t. For example, derivatives are investments ‘derived’ from other investments. An option is a derivative that gives the owner the right to buy or sell a specific amount of a given security at a specified price during a specified period of time. Options are generally classified as investing rather than gambling, and rightly so, but they do not represent ownership of anything tangible. However, when you realize that an option is essentially a bet that a given security will or won’t be above a certain price on or by a certain date, it starts to feel more like gambling than investing.

An even more strict definition of investing would require that it involves the purchase of an asset which either produces a stream of income or can be made to produce a stream of income. But this definition would eliminate such assets as collectibles, stamps, art, and gold, which have no intrinsic value. I don’t think it makes sense to exclude them simply on this basis. We might choose not to consider them investments because of their poor long-term performance, but we shouldn’t choose not to consider them investments simply because they won’t ever produce a stream of income.

Investing is based on skill and requires the use of a system based on research, while gambling is based on luck and emotions.

A lot of so-called investors don’t do nearly as much research as they should. Many buy on tips or rumors, or based on some analyst’s price target, without doing their own exhaustive research. It feels right to call such behavior gambling. Similarly, investors who are making decisions based on emotions (especially greed and fear), rather than remaining emotionally detached and sticking with their strategy, are to some extent gambling.

On the other side of the coin, some gamblers do serious research, often paying hundreds of dollars a month for real time data on what the current lines are (for example, on http://www.scoresandodds.com or http://www.vegasinsider.com). Professional sports investors devote 12 hours a day, every day, to handicapping sports. They read dozens of newspapers, subscribe to line services, maintain inside contacts, and have years of experience, usually on both sides of the betting counter. These professionals keep their emotions away from the decision-making process. Once they have a system that works for them, they don’t second-guess it, focusing on long-term profits instead of day-to-day performance. Also, they concentrate on the areas in which they achieve maximum results. Many professionals bet only on one sport, which bears more than a superficial resemblance to Warren Buffett’s idea of staying within one’s “circle of competence”.

While investing and gambling probably initially appear to be worlds apart, the above attempts at differentiation revealed that the actual differences are smaller than the perceived differences, and that there is a significant gray area in the middle. Based on the above characterizations, it is clear that the appropriate classification isn’t wholly dependent on the activity, but also on the way in which the activity is conducted. There’s a big difference between buying a stock after thoroughly researching it and buying a stock by hitting it on a dartboard. This is true even if the same stock happens to be chosen. Similarly, there’s a big difference between buying exotic derivatives to hedge against an existing risk or position and buying the same derivatives because you saw a web site touting them. As a final example, there’s a big difference between buying a government bond in order to collect the interest it earns and buying the same bond in the belief that interest rates are about to drop and the bond’s value will skyrocket.

One interesting thing to note is the pattern of exceptions to the attempted characterizations. Most of the exceptions were people who were doing investing-related things but weren’t behaving like investors, or people who were doing gambling-related things but weren’t behaving like gamblers. Of the four groups, recreational investors, professional investors, recreational gamblers, professional gamblers, there are more similarities between the two recreational groups and between the two professional groups than between the two investing groups and between the two gambling groups. Specifically, those who use a rigorous system, do research, tilt the odds in their favor, treat it as a business rather than as entertainment, avoid addiction, and keep their emotions in check tend to behaving like investors, and those who don’t tend to be behaving like gamblers. It might not be such a stretch to call professional gamblers ‘investors’ and recreational investors ‘gamblers’.

A Third Option: Speculating

Another possibility is that the two terms ‘gambling’ and ‘investing’ aren’t sufficient to cover the entire range of activities under consideration. A third term, ‘speculating’, is often used to straddle the two, specifically to handle activities that would ordinarily be considered investing but are done in a way that make them feel more like gambling.

In The General Theory of Employment, Interest, and Money, John Maynard Keynes defined speculation as “the activity of forecasting the psychology of the market”, and speculative motive as “the object of securing profit from knowing better than the market with the future will bring.” Many people consider billionaire George Soros to be an investor, but he prefers the term speculator. In fact, he has said that “an investment is a speculation that has gone wrong.” What he means by this is that, among speculators, an ‘investment’ is the name they give to a speculation that didn’t work out the way they expected and that left them stuck with a position they hope will improve with time. Soros and other speculators make their predictions partially based on market psychology, and in this respect their behavior fits perfectly with the Keynes’ definition of speculation. But there is much more to speculating than just interpreting market psychology, and this definition isn’t sufficiently distinct from the ones we formulated for gambling and investing in the above section.

According to the dictionary on my bookshelf, speculation is “the engagement in business transactions involving considerable risk for the chance of large gains.” By this definition, the entire distinction rests on the degree of risk and size of potential gains. In support of this definition, bond rating agencies commonly use the term “speculative” to refer to high-risk bonds (those rated below BBB by S&P or Baa by Moody’s).

In their book Investments, Zvi Bodie, Alex Kane, and Alan Marcus argue that “a gamble is the assumption of risk for no purpose but enjoyment of the risk itself, whereas speculation is undertaken in spite of the risk involved because one perceives a favorable risk-return trade-off.” But this is too simplistic. no one would play casino games if the only possible outcomes were either breaking even or losing; the rush they experience comes from the possibility of winning and not merely from the taking of risk. They continue: “To turn a gamble into a speculative prospect requires an adequate risk premium for compensation to risk-averse investors for the risks that they bear. Hence risk aversion and speculation are not inconsistent.” This part I agree with. In fact, whether they realize it or not, their definition reclassifies gambling as speculation when the odds can be sufficiently tipped in the player’s favor, such as in professional blackjack or poker, which fits in nicely with argument made in the previous section.

Zvi Bodie et al appear to be saying that in order to be speculating rather than gambling, the person must not take greater risks than are justified by the potential reward. Others say that in order to be speculating rather than investing the person must be taking greater risks than are justified by the potential reward. For example, in Benjamin Graham and David Dodd’s classic Security Analysis, they argue that “an investment operation is one which upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.” Both positions are defensible. But perhaps a better interpretation would rest on the realization that different investors have different tolerances for risk. Perhaps speculators are those who are risk-neutral, while gamblers are risk-seekers and investors are risk-averse. While adding the term ‘speculation’ to the mix might have some value, it probably adds more confusion than clarification, so I prefer to leave it out and focus on just ‘gambling’ and ‘investing’.

Conclusions

So what’s my resolution to this definition conundrum? Well, the purpose of words is to communicate concepts. So it doesn’t really matter what definitions you use, as long as you and the person(s) you’re communicating with are clear about what is meant by those words. And even more importantly, as long as you know what you’re doing, investing or gambling, before you do it.

But with that said, it would be beneficial if everyone could agree on what the terms mean, so we don’t need to make our definitions explicit every time we want to use them. To this end, I offer the following definitions, which are built from the various characterizations in the above section:

Investing:

“Any activity in which money is put at risk for the purpose of making a profit, and which is characterized by some or most of the following (in approximately descending order of importance): sufficient research has been conducted; the odds are favorable; the behavior is risk-averse; a systematic approach is being taken; emotions such as greed and fear play no role; the activity is ongoing and done as part of a long-term plan; the activity is not motivated solely by entertainment or compulsion; ownership of something tangible is involved; a net positive economic effect results.”

“Any activity in which money is put at risk for the purpose of making a profit, and which is characterized by some or most of the following (in approximately descending order of importance): little or no research has been conducted; the odds are unfavorable; the behavior is risk-seeking; an unsystematic approach is being taken; emotions such as greed and fear play a role; the activity is a discrete event or series of discrete events not done as part of a long-term plan; the activity is significantly motivated by entertainment or compulsion; ownership of something tangible is not involved; no net economic effect results.”

“Investing or gambling characterized by a high degree of risk and a high potential for reward.”

Why Does it Matter?

  • Lawmakers and regulatory bodies need to be clear on what the terms mean, so they understand the scope of their legislation and regulation, regarding prohibited behavior, adequate disclosure, participant protection and similar issues. In general, I’m in favor of less regulation and more disclosure for both activities described as gambling and those described as investing, but I’m no expert on the subject and a thorough discussion is beyond the scope of this essay.
  • Everyone needs to realize how easy the internet makes it to gamble under the guise of investing. When people use generic terms without ever specifying what they mean, it’s easy for those terms to gradually change in meaning, and I think that’s exactly what the internet is causing to happen. I don’t mean to imply that the internet’s democratization of investing is a bad thing. In fact, I think it’s the one of the most important developments in the history of investing. My hope in pointing this out is to awaken those individuals who are acting like gamblers but who think they’re acting like investors.
  • Investing addiction is as serious as gambling addiction, and should be treated as such. If more people start to view buying and selling stocks online as a way to get the betting rush that previously required a trip to a casino, is there any reason to think the same negative consequences that follow gambling won’t also follow investing? Perhaps investing addiction is not getting the attention it deserves because most people are attaching to it all the positive connotations of investing and none of the negative connotations of gambling.
  • Those who have ethical problems or religious issues with gambling (or even investing) owe it to themselves to figure out exactly what they object to and why. As I mentioned, I have no such ethical problems with either gambling or investing, but again, this discussion is beyond the scope of this essay.

I’ll leave it to Benjamin Graham to further emphasize why such clarity is essential. In The Intelligent Investor he said:

“The distinction between investment and speculation in common stocks has always been a useful one and its disappearance is a cause for concern. We have often said that Wall Street as an institution would be well advised to reinstate this distinction and to emphasize it in all dealings with the public. Otherwise the stock exchanges may some day be blamed for heavy speculative losses, which those who suffered them had not been properly warned against.”

“Outright speculation is neither illegal, immoral, nor (for most people) fattening to the pocketbook . . . There is intelligent speculation as there is intelligent investing. But there are many ways in which speculation may be unintelligent. Of these the foremost are: (1) speculating when you think you are investing; (2) speculating seriously instead of as a pastime, when you lack proper knowledge and skill for it; and (3) risking more money in speculation than you can afford to lose.”

INVESTING; GAMBLING ON OPTIONS WITH I.R.A. MONEY

By John C. Boland

    March 9, 1986

BROKERAGE firms have begun expanding the risks investors take in their individual retirement accounts. Last weekend, Brown & Company, a Boston-based discount affiliate of Chemical Bank, introduced a national advertisement inviting I.R.A. customers to ”go ‘long’ options” – that is, to buy the volatile instruments outright for speculation on the stock market. The practice, while controversial and not yet widespread, has been quietly permitted in I.R.A.’s by a number of other brokerage houses, usually for large customers, and competitive pressure to attract more I.R.A. money seems destined to prompt more firms to relax restrictions.

”We try to keep it to a minimum,” said an executive at Robert W. Baird & Company, a regional firm based in Milwaukee. The Baird employee, who asked not to be named, estimated that the firm’s management had cleared less than 1 percent of the firm’s I.R.A. accounts to trade options. ”We just don’t like it,” he said.

Brokers may face legal perils in accepting such business, because there is an active debate over whether high-risk instruments are suitable for retirement accounts. If a small investor decimated his or her I.R.A. by playing the options market, the prudence of the account’s custodian – usually a bank or a broker – might be called into question. Thus brokerages are usually loosening restrictions only for higher net-worth customers, who presumably are more sophisticated. So, while Brown & Company has opened the options’ door to anyone with a $25,000 net worth, its president, George A. Brown, said: ”We want to see more if we can. And we want to see some experience in option trading.”

The Internal Revenue Service, which oversees retirement plan laws, has no guidelines prohibiting I.R.A.’s from trading in options or, for that matter, in futures contracts, which could cover anything from stock indexes to heating oil to currencies. The only forbidden investments, broadly speaking, are collectibles such as precious metals, personal residences and businesses (under the heading of self-dealing), and investments that involve borrowed money, such as leveraged real estate, margined stock or short sales. The I.R.S. is studying whether it should ban the use of futures contracts or options on collectibles. ”We don’t have a firm opinion on whether buying futures is the same as buying the collectibles,” an I.R.S. spokesman said.

Since last year, Merrill Lynch & Company, which has 1.3 million I.R.A.’s controlling $15 billion in assets, has offered managed futures trading partnerships to its larger I.R.A. customers. The account must total at least $50,000 (such a large I.R.A. could be the result of a rollover) and no more than 10 percent of assets may be used in the volatile futures game. E. F. Hutton and Thomson McKinnon Securities offer similar limited partnerships. A spokesman for Rudolf Wolff Commodity Brokers Inc. said the firm had ”just a handful” of self-directed I.R.A. accounts trading futures directly.

The prospect of options and futures catching on in I.R.A.’s worries some onlookers. ”In an I.R.A. account you should take a conservative attitude, slow and easy,” said Patrick Miller, office manager for Thomson McKinnon in Baltimore. ”If you speculate in the account, you’ll get an occasional home run. But you’ll get a lot of strikeouts, too.”

Not every options strategy is fraught with danger. Most brokerage firms have routinely permitted investors to write calls against stock held in an I.R.A., a tactic that can generate income and limit downside risk. Though it does not promote the practice, Merrill Lynch also allows purchases of puts to hedge specific stock holdings against a price decline. So far it has held the line against allowing I.R.A. customers to buy call options, which are a bet on higher stock prices. ”We are looking at whether we should expand this,” said Donald Underwood, head of Merrill’s retirement plans.

Janney Montgomery Scott Inc., in Philadelphia, which has ”maybe a few hundred” accounts of more than $10,000 cleared for options trading, requires that customers sign an additional release stating that ”they realize it’s very speculative and that it might not be a good idea,” according to Gail Simon, vice president and head of retirement plans.

Interviews with brokers and lawyers at a dozen concerns found wide agreement that competitive pressure is a major factor. ”We would love to say ‘No, you cannot do options in an I.R.A.,’ ” said the executive at Baird. ”A year ago, we did. But due to market competition we’ve relaxed that and permit long options on a case-by-case basis.”

While a broker who restricts trading risks losing accounts, the cost to investors plunging into options can be catastrophic, according to many analysts. The arguments against high-risk instruments in tax-deferred accounts can be summed up this way: the chance of loss is high, the losses in an I.R.A. cannot be written off against income, and money lost cannot be replaced by additional contributions.

”Long options are extremely speculative,” said John Bradburn, sales manager for Merrill Lynch in Baltimore. ”They have no intrinsic worth.” To use them in a retirement account, he added, would be ”from a fiduciary perspective, very irresponsible.”

The Baird executive noted: ”Less than 5 percent of long option buyers consistenty have capital gains. It just doesn’t happen. So if the options are 20 to 1 against you, why put it in a tax-deferred account where there’s no way to write off a loss against your income?”

Even hedging with puts, to protect against a price decline, makes little sense, argue some analysts. In an I.R.A., there is no tax reason not to take a profit by selling stock, if an investor fears a slump. GETTING OUT OF MUNSINGWEAR

Munsingwear Inc.’s controlling investors have apparently decided that it is time to cash out. The Minneapolis-based maker of underwear and sports clothing filed registration papers for a 1.25 million-share secondary public stock sale last week with the help of Prudential-Bache Securities Inc. At least 928,000 shares will be sold by the Texas-based Bass Brothers group.

At first glance, the timing looks opportune for investors to jump into Munsingwear: Reported earnings have been staging a rebound, on higher sales. But a review of the initial prospectus would reveal that most earnings are from one-time benefits.

The Bass Brothers, who own 45 percent of Munsingwear’s common, could sell all but 5 percent of their stock back to the public, if the maximum shares are sold. The Bass Brothers’ cost is well below the stock’s recent $20.63 high (the 52-week low is $8.87; last week the stock was around $18). Munsingwear’s management holds less than 1 percent of the common.

In 1985, Munsingwear’s revenue, lifted in part by an acquisition, climbed 23 percent, to $114.2 million. Final earnings per share were $1.12, seemingly quite a comeback after big losses in 1979-82.

Yet extraordinary items contributed most of the net: The sale of several plants, a sale of lease rights, tax loss carry forwards.

Actual profits from selling apparel in 1985 were a paltry $60,000 before taxes – a couple of cents a share. The stock has been trading at a premium to an $11 book value. That may explain why smart professional investors such as the Bass Brothers have decided the time is ripe to shed Munsingwear.

What’s the Difference Between Investing, Speculative Trading, and Gambling?

Hi there! I am a finance professional and am interested in finance, technology, and everything in between.

It is dangerous to confuse investing, trading, and gambling!

You’ve heard the stories. You’ve seen the news. People spending their money in casinos, mortgaging their houses to buy Bitcoin, and blowing hundreds of dollars on the lottery.

No way”, you think to yourself, “I know better than that. My money will be well invested and will grow for the long run.”

Then, you see an online course promising to teach you binary options trading. “Hey”, you think, “This looks like something that I can invest in and make my money grow!” So, you open an account and start to bet on whether AAPL will close above $250 in the next week.

Are you really investing, trading, or gambling? Is betting on the market via binary options, leveraged FX, and the like any better than entering a casino and putting down 10 chips for “22, Black!”.

Knowing the difference between the three categories can save you more than a pretty penny – it can also lay a solid foundation for your future wealth, and drill in certain concepts that will stick with you throughout your working life and retirement.

If you confuse investing, trading, and gambling, you are on the fast track to lose money!

Let’s start with what everyone should be doing – investing.

Investing should be the least controversial and the easiest to understand. After all, entire business models and many, many websites are dedicated to this topic.

I shall not try to reproduce the entirety of their content here. Instead, I will stick to broad principles with the intent to differentiate investing from the other two activities.

For starters, why would people even want or need to invest? The underlying principle of inflation is the cause. This concept says that generally, a dollar tomorrow is worth less than a dollar today. Stretch that concept over decades and your dollar 40 years down the road will be worth pennies of the dollar today.

As an example, if you buried $100 in your garden today and retrieved that same $100 a decade later, that same $100 will not be able to afford you the same level of purchasing power as a decade ago. This is because the prices of the goods and services you want to buy has increased, but your dollar has remained the same.

I don’t need to elaborate this point, as I’m sure you are all aware of the dangers of inflation. So then, investing is one of (if not the only) way to grow your money, and to ensure that you are able to maintain your purchasing power into the future.

to commit (money) in order to earn a financial return.

So then. what IS investing?

In my view, the core principle behind investing is actually delayed gratification.

Because, the alternative to setting aside money to invest for the future is to spend money today.

Thus, investing is an active choice to deny yourself the pleasure of instant gratification and instead, put the money towards your future and delay your gratification.

This would be the core basic principle that I will use to determine if what you are doing is actually investing (as I personally feel there is some overlap with trading, but I will cover that later). The idea here is that you are setting aside money that you could have spent today, for it to grow in the future.

Of course, the methods of investing differ. I can argue that setting aside money in a fixed deposit account for future spending is still investing, albeit just not very efficient nor effective way of doing so (since the returns on that investment may not help you beat inflation at all – it is more like saving instead).

While saving is good and is necessary before investing, that is a different topic for now.

So, the idea here is that you are deferring gratification and putting your money to hard work at the same time! All to defeat this nasty thing, called inflation.

the act of buying something hoping that its value will increase and then selling at this higher price in order to make a profit.

— The Cambridge Dictionary

Now, let’s move on to speculative trading.

Why do I pair ‘speculative’ with ‘trading’? Is it possible to trade without speculating?

I don’t think so.

The whole idea behind trading is to ‘buy low, sell high’, and not necessarily in that order (as can be seen from the dictionary definition above). This differs from investing in both time frame and velocity (i.e. how fast you are in and out of the position).

Thus, if you are trading, it is almost always because you are speculating.

The confusion now arises between such trading and gambling. What sets the two apart?

Before I go into this, let’s take a look at gambling, since the differentiation between the two is more nuanced compared to the difference between trading and investing.

the activity or practice of playing at a game of chance for money or other stakes.

What is gambling?

We now come to the last category – gambling. The dictionary definition is quite self-explanatory, since the whole concept revolves around luck and chance.

With mathematics, statisticians have built businesses relying on probability and human behavioural traits, leading to industries like casinos, sports betting, and lotteries. Such probabilities always skew towards the house, as long as sufficient numbers of people participate. (I mean, have you seen the profits that casinos make?)

This section about probabilities can take up a whole post (or three!) on it’s own, so I will leave the definition here as a game of chance.

Now then, comes the important question – is speculative trading any different from gambling?

What are the main differences between speculative trading and gambling?

While speculative trading can seem like gambling, there are a few key differences between trading in a manner that can seem more like investing, and trading in a manner that is just outright gambling.

In my view, the questions to ask yourself to assess whether you are more likely to be trading or gambling are:

  • Do you have a trading plan? This includes profit taking, stop losses, and a backtested (or at least theoretical) trading model.
  • Is your intention to get rich quick?
  • Is this part of your overall asset allocation?

Let’s take a deeper look into these questions.

Do you have a trading plan?

If you have a trading plan, it is less likely that you are gambling, because this means that you have done the homework, analysed the probabilities, and are willing to accept the risk/return trade-off that accompanies the plan.

Of course, sticking to the plan (particularly when you have to cut losses) is another thing altogether, but the concept is there.

Some key elements of a trading plan include:

  • The strategy. Trading is about strategy, particularly because short-term movements of the markets are notoriously hard to predict. There is still an element of chance, but you would have analysed the probabilities and developed the strategy to accept certain probabilities of loss and profit, which would enable you to make money (at least theoretically) in the long term.
  • Entry and exit points. When trading, it is not about ‘feelings’ or ‘hopes’. There should be a consistent way you do things, which will then allow you to have a sample to evaluate whether your plan is working as intended. If you do not follow your system and just enter and exit at will, it will be harder to see if your system is actually working, and would then seem more like gambling.

Just to note, this includes profit-taking and stop-loss points. I know that such points (stop-losses in particular) are hard to follow, and I’m also guilty of holding an investment for far too long when I should have cut my losses instead. But the idea is with proper money management, you will be able to trade in a systematic way that allows you to refine and tweak your strategy.

  • Trade sizes. Even with a strategy, you do not just allocate your whole trading budget into one trade, no matter how good the probability is. You would need to have a trade sizing discipline so that you don’t risk all your capital on one trade – there is always the possibility that things go massively wrong.
  • So, if you have a proper trading plan and follow it (reasonably), I would say that the chances that you are gambling are pretty low.

    However, if you treat trading like your personal slot machine and just buy something ‘because you felt like it’ or ‘hope that it’ll go up/down’, then it is more likely you are just gambling and not trading.

    If you recall the definitions, when you start gambling, the odds are always against you (because the house would ensure it), and you will then lose over the long term. Yes, you may get lucky and win now and then, but just like any casino, the longer you gamble, the larger your losses grow.

    If you need any examples of this type of gambling, you need not look further than all the rogue trader scandals (with a famous one bringing down a bank). Please don’t let that be you.

    Do you intend to get rich quick?

    Ah, the famous “get rich quick” quote. Intentions are hard to determine, so this will require some level of self-reflection to understand your true motivations.

    Even if you trade speculatively, the idea is not that you will be able to retire immediately as a millionaire after a few trades. Speculative trading is a hard business, especially as a retail trader, because the big institutions will deploy better, faster, and more sophisticated algorithms than you.

    So, it will be a grind. You will not get rich quick.

    Thus, if your primary motivation in trading is to strike gold and retire on a private island, sorry, but it looks like you are gambling, not trading.

    I’ll leave you with a statement that I remember from the trading classes I took previously:

    “If you follow your trading plan properly, you should see decent returns of maybe 10-20% a year. If your trades start earning 20% a month, you should review your plan because it is likely that you are taking on too much risk in your portfolio.”

    This brings me to the asset allocation question:

    Is trading part of your overall asset allocation?

    This is more of a personal opinion, but if you do trade, it should be done within the framework of your overall asset allocation.

    This is where trading can intersect with investing.

    Of course, there are many people who invest without trading. There is nothing wrong with that. What I’m saying is that if you do trade, it should be done with regard to your overall portfolio and asset allocation strategy.

    This will put your trading in perspective, since it gives you a more bird’s eye view of your own portfolio. Using finance terminology, trading could sit within the ‘tactical’ asset allocation segment of your portfolio.

    Conversely, if your trading is done in isolation, then there is a higher chance of it being just gambling.

    Summing up – why it is important to know whether you are gambling

    If you apply all the above, it should give you some indication of whether you are gambling or trading within a proper investing framework.

    The danger is when you don’t realise you are gambling, and instead think that you are trading or *gasp* investing. That is when people do things like mortgage their houses for bitcoin, leading to massive problems when they don’t fully know what they are getting into, but just FOMO-ing into it and hoping to get rich quick.

    Gambling, by itself, is of course not encouraged in the broader scheme of things, but if you do decide to gamble, that is your decision and I am not here to dictate what you should do. If you like playing blackjack, poker, or view the slots as a form of entertainment, that is your decision.

    Just be mindful that if you transition from a casino to the financial markets without being clear on what you are doing, you may lose more than just your trading account.

    This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.

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