Gambling Vs. Investing: A Comparison
Posted on Monday, October 1st, 2007 | In Investing LessonsWe have tried to draw a clear distinction between investing and gambling. We believe that the analysis of gambling situations frequently provides more data, allowing a long-run analysis. The techniques used are the same that investors should use in evaluating stocks and sectors.
The Danger
Those buying stocks, whether their time frame is short-term or long-term, frequently focus on the return rather than the risk. This can take two distinct forms:
- 1. Believing in the apparent consistency of returns. This has been costly for investors in mortgage securities, either directly or through hedge funds that leveraged these instruments.
- 2. Swinging for the fences. The investor looks at the potential gain rather than the risk.
The Gambling Lesson
Seeing the risk/reward error is extremely difficult when one already has an investment position. The gambling comparison can help one take a completely different perspective — one where there is no psychic stake in the outcome.
Accrued Interest provides several lessons on this theme in an excellent post today. The points are difficult to summarize, so we recommend reading the entire article.
Tom Murcko at InvestorGuide.com also provides a thoughtful comparison of investing and gambling, including a good intellectual framework.
Our own comparison is also helpful.
Conclusion
Looking for understanding from different, but analogous situations, is a strong method for improving investment performance.
Many approaches are working well, but investors need to choose with a realistic assessment of risks.
Last 5 posts by Jeffrey Miller
- A Tough Nut to Crack - October 29th, 2009
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- Healthcare Reform Becoming Less Likely - October 21st, 2009
- ETF Update: Another Look at the Banks - October 18th, 2009
- Identifying Quackery (and Other Mistakes) - October 6th, 2009
 About Jeffrey Miller (http://www.oldprof.typepad.com)
Jeffrey A. Miller, Ph.D. is a former college professor with a hands-on, real world attitude. His quantitative modeling helped inform state and local officials in Wisconsin for more than a decade. A Public Policy analyst, he taught advanced research methods at the University of Wisconsin, and analyzed many issues related to state tax policy. In 1987 Jeff began work for market makers at the Chicago Board Options Exchange. His approach included finding anomalies in the standard option pricing models and developing new forecasting techniques. Merging these quantitative techniques with specific company analysis, Jeff also generated trading ideas from sell-side analyst reports. Through his years of experience in trading options, futures and equities, Jeff has come to be regarded as an expert in interpreting the effect of news on the markets and individual stocks. Jeff has served as a forensic expert in several cases involving such issues. He has also written a series of papers on investment management, describing both quantitative methods and those related to behavioral economics. |
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