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Is trading similar to gambling?

BY READERS DIGEST

29th Mar 2022 Managing your Money

Is trading similar to gambling?
Trading and gambling have more similarities than differences in practical. However, understanding the differences between the two can improve your trading strategy to a great extent.
In gambling, the house or gambling establishment mathematically structures the events in such a way that they will always gain in the long term. For example, the imposing casinos that you enter in the hope of making a fortune are built from the money lost by individuals like you.
Despite maintaining glamorous premises and paying salaries to the workers, the casinos make phenomenal profits each year through the money lost in gambling. 
In trading, you can either be a gambler or a house depending on your efforts, efficiency, skill, and experience. It is important to understand that trading and investing have differences.
Trading means buying and selling securities in a short tenure to make potential profits. While investing refers to holding onto your position for a longer term.
We will attempt to understand the similarities and differences between gambling and trading. Also, we will discuss factors that can enhance trading strategies and avert a trader from being an audacious gambler in the financial markets.

Gambling tendencies in trading

The tremendous growth of trading volumes in recent years has also increased the number of uninformed and inexperienced traders in the market. Traders who open a trading position without prior knowledge and reasoning to justify it are simply gambling in the financial markets.
Following are some of the major traits that signal gambling tendencies in trading.
  • Motivation behind trading
Many beginners in trading try to get rich quickly inspired by the success stories of once in a blue moon or highly experienced traders. The motivation to enter the trading world can also be social proofing (because everyone is doing it) or fear of missing out (FOMO).
Lucrative advertisements by brokers and widespread news of a boom in the market during a bullish trend may also attract individuals to trade.
The emotion-based motivation to trade generally leads to making uninformed decisions in a trade. This is similar to gambling.
Even if you book profits in the initial trades, it is very likely to lose all the profits in successive trades without clear motivations & education. Placing random trade orders without an understanding of the working and price movements of capital markets, and that asset is nothing less than gambling.
  • Trading with the unknown
The selection of financial instruments and capital markets is an important step in trading. Trading with a financial instrument because it is trending or giving better returns should never be the basis of selection.
Each instrument of every capital market has different traits, risks, and their prices can move differently due to multiple reasons. It is important to seek the available information about the financial instrument, its price movement history, and the factors affecting its price movement before placing trade orders.
A trader gambling in unknown financial instruments is very likely to face drastic outcomes.
Selection of broker should also be done after thorough analysis and comparison. Apart from fees and other features, the regulation, safety, and trust factor should also be checked. Trading with an unregulated or fake broker can also be considered a gamble due to significant third-party risk.
  • Not accepting loss
Every individual placing a trade order aims to book profits on each trade. However, the outcome of many of the trades would likely not be as per the anticipation. While facing losses, some traders add on to a loss-making position hoping to recover the lost amount.
For example, you placed a buy order on Stock A and its price started depreciating after execution of the order. You place another buy order at a lower price of stock A in hope of recovering the losses. If the price further depreciates, you might lose all your invested amount.
This is quite similar to gambling as there was no analytical reasoning for the subsequent order.
In this example, if you closed the position instead of placing another order or used the stop-loss feature, the losses would have been much lesser.
Even the most experienced traders face losses, but they are quick to cut their losses within time, as per their plan.
  • Not following a strategy
Creating, following, and improving the trading strategy based on fundamental and technical analysis is what separates trading from gambling. If you are not following a strategy based on research and analysis, there is no difference between trading and gambling.
Each trader can have their own strategy based on analysis through charts, indicators, financials, news, economic effect, etc. The trading strategies can be tested with virtual  balance on demo accounts or with small amounts to increase efficiency and check suitability.
Strategies of successful traders can be conceptualized to build or supplement your strategy. However, completely copying trading strategies or mixing up multiple strategies is not advisable as each strategy is suitable for different types of traders.
Learn as much as you can, and learn how you can manage the risks.
  • Use of excessive leverage
Leverage in trading allows the trader to open bigger positions with smaller deposits. However, the leverage can also act against you if the price moves against the trade. The use of excessive leverage can result in much worse outcomes than that of gambling.
For example, you placed a buy order with $1 on stock B with leverage of 1:100. This will allow the trader to gain $50 if the price moves up by $0.50. But if the price goes down by $0.50, the trader will face a loss of $50.
The initial deposit in this trade was $1 but due to leverage, the loss can be much more than that.
Saurav from Forex Beginner UK, a comparison & education website for trading, warns that as high as 85% of the retail traders in the UK lose all the amount held in their trading accounts with several CFD brokers when trading CFDs & other derivatives because they use excessive leverage in their trades. This is as per an average calculation of percentage of losses data that the FCA regulated CFD brokers are required to publicly disclose on their websites.
Several financial regulators including the FCA restrict brokers from offering excessive leverage to retail traders, but unregulated trading services providers continue to attract retail traders with high leverage.

Why all traders are not gamblers?

Most of the retail traders lose their money with online trading. But despite multiple similarities with gambling, there are some professional traders that are making consistent income through trading by following risk management.
This is not the case with gambling because of the fact that the gambling service provider is running a business to make money from your losses. The trading service provider makes money with the fees and commission for facilitating the trade orders made by you.
Professional traders have certain traits that allow them to book regular profits. These traits have separated them from being a gambler in capital markets for years.
  • Discipline: Discipline plays a major role in keeping oneself on the safer side in trading. Greed, fear of losing, or adrenaline rush should not take over your decision-making ability in trading. Professional traders do not let their emotions or sixth sense drive their trading decisions. 
  • Protect Capital: Professional traders are well aware of their risk appetite and never take excessive risk in a trade. In case of an unwanted outcome, protection of capital is their first priority. One should never trade without stop loss as waiting for recovery of the loss in trading can be hazardous.
  • Risk to Reward: By analysis of the charts using indicators, one can get the gist of the upside and downside potential of the capital market. The possible profit margin can be compared with possible losses to predict a risk to reward ratio. Professional traders strictly follow the safe risk to reward ratio of more than 2 but it largely depends on the market conditions.
  • Fewer Trades: Professional traders do not trade throughout the active hours of the market but wait for the right moment to enter a trade. Trading more frequently can lead to overtrading which is dangerous. An informed trader will always choose slower profits over quick profits.
  • Safe Leverage: The leverage feature can be very useful in making better returns. Traders should learn to manage leverage according to the risk factor of the trade order. Professional traders use leverage on low-risk trades and use much lower leverage on high-risk trades.
  • Trade Familiar Market: Traders should only trade in markets with studied price trends. Trading on multiple capital markets might distract traders leading to wrong decisions. The casinos only allow gambling on games that give them an advantage over gamblers. 

Conclusion

The similarities and differences between gambling and trading depend entirely on the approach of the participant.
For those having no knowledge and experience of trading strategies and capital markets, trading is similar to gambling. Although, even in gambling, the house or casino always gains from gamblers because they play safely with probabilities.
For better outcomes, traders should always think and act like a gambler in the financial markets. Taking precautionary measures and adequate research and analysis can give you an advantage in trading.
Gamblers are destined to face losses eventually but traders can either play the role of a gambler depending on their skill set, risk management and experience.
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