Saturday, 21 January 2017

Trading Versus Gambling

I would like to tell you without a doubt that trading in the markets is not like gambling at all.  Trading is simply a vehicle to generate cash flow just like a business, whereas gambling has a fixed odds system for all major games.  The market does not have any unfair advantage as with casino style games, card games or racing.

Many gamblers visit casino or casino like place, step up to a table to play a game with money on the line and hope to earn a fortune.  However, these gamblers fail to understand that the massive casino that they have stepped into was built with the money lost by people before them who didn't understand the odds that the casino that hosts the game makes sure the odds are tilted in their favor, in the favor of “house”.

Unlike gambling, in trading the traders will be dealing with markets that do not ultimately care whether they win or lose.  With enough knowledge about the markets and trading, expertise on the trading method, extreme discipline, dedication and honest and genuine efforts, traders can profit in the market.  However, if traders approach the market with random abandonment, then the market can and will cause serious pain.

Now let me try to help you recognize if you are displaying characteristics of a gambler and not a trader.

1.  Trading without proper understanding of markets and trading system.

Few weeks back I did a small quiz to help traders test whether they have a sound understanding of the trading system that they trade with.  If you have not been able to test your existing knowledge yet, click here.  The eye-popping results were like this,

Less than 10% of the respondents scored complete marks.
More than 60% of the respondents scored less than 50% marks.

The results proved that majority of traders were trading without enough knowledge of the trading system.  They lacked even the basic understanding of how the system works.  By looking at the results one would never wonder why they were still losing money while trading.  They took it as a sort of gambling and that is the main reason, they did not seriously think about educating themselves first and do all the preparation.

If you do not know how to drive the car, will you attempt driving it?   If you do not know how to operate a patient, will you dare to do a surgery?  If you do not know how to fight with the professional boxing champion, will you show courage to jump into a boxing ring?  You will obviously not do it.  Then why in trading, you start trading without knowing how to trade.  Why do you treat trading differently?  If you start trading without knowing how to trade, you will for sure harm yourself very badly, simply because you do not know how to do it.  You will ruin yourself financially and emotionally.

2.  Going all-in or taking large trading bets on small capital.

If you find yourself going all-in on trading positions, this is a sign that you are taking unnecessary risks for the hopes of a windfall profit.  For an example, you would be doing this if you have 100k cash, you use 400k margin on that and you are using all 400k for one day trade.  If you like to take large option trade positions in the hopes of making 10x of your money, what you are doing is, just gambling.  So if you find yourself occasionally or worst frequently going all-in on a sure bet, this is a clear sign that you are crossing the line from a good trader to characteristics of a gambler.

3.  Overtrading.

Gamblers will often try to bet themselves out of a hole, which most times leads them further into the ruin.  As a trader, you can too display similar behavior with the market if you go on a bad run.  No matter how good you are as a trader, you will encounter dry spells.  It will feel like the market is against you and you are unable to pick a winner.  Smart traders will either stop trading for a period of time or will start to take smaller positions until they are able to sort through their slump.

I remember a time where I was day trading and the market had given me a few losses by noon time. Instead of trading smaller or stopping altogether for the day, I decided to “beat” the market.  I considered myself like a hero Rajnikant who can handle any worst situation and fight and beat hundreds of people.  So I began taking on position after position, so much so that by the end of the day I felt like I had been through a mixer grinder.

Same way if you are becoming somewhat of a gambler, you will notice that the majority of the time you are overtrading.  This need to overtrade is the same thing a gambler feels when they need to place more bets to “fix” the problem.

4.  Overleveraging or using credit for trading.

Under no circumstances should you be using credit cards or taking out loans or borrowing money from the loved ones to place money in the market.  Think about it, the market already provides you margin which allows you to trade above the available cash on hand.  Why would you need more money?

It is one thing to lose your own money, but you should never allow the market to place you in a position where you are going in debt due to your trading.  If you can’t turn a profit with your own cash, what makes you think you will turn a profit with borrowed money?  It’s not about trading larger in order to make money; it’s about trading smarter with what you have on hand. So if you are surviving on a borrowed capital, stop whatever you are doing and replace these funds immediately.

5.  Mental stability.

A major sign that someone is a gambler and not a trader is when they lose their mental stability. They will have mood swings that start to fly all over the place.  They will be high as a kite one day and then completely depressed the next day.  Trading if not treated as a business can have the effects on your relationships.  You will find yourself avoiding your loved ones because you don’t want to face if they ask you how your trading is going.  You will start to find time with your family as a distraction from your very important task of performing more and more market analysis.

Trading should have no impact on your emotions.  You should remain as calm and as composed as ever.  This is always the first sign of a good trader, the ability to stay completely flat in an environment that is filled with emotions such as winning and losing, fear and greed.

6.  Trading rules.

If you are finding yourself abandoning rules in order to place random bets in the market, you are not a trader.  This is a clear sign that you are no longer concerned with establishing a rationale for your trades and have instead opted for the ability to place trades whenever and wherever you want.  This sort of behavior is similar to the gambler who is not concerned with calculating odds, but would rather just stay in the game and place bets.

In trading, you have to have a number of fixed rules that govern how you do your trading and conduct your business.  You require to make your own rules for identifying the trade setups, for entry and exit, for money management, etc.  You also need to understand the rules of the market and you need to abide by those rules.  There should not be any scope for deviation from these rules.

7.  Record keeping.

Are you keeping your trading records?  Are you aware of your current profit or loss situation?  If your answer is yes, then you are a good trader. If your answer is no, then you may be more inclined towards gambling rather than trading.

Good record keeping helps us measure our performance as a trader, rate our progress, and learn from our mistakes.  If we do not learn from the past, we are doomed to repeat it.  If someone wants to become a better runner, keeping records of speeds is essential for designing better workouts. If money is a problem, keeping and reviewing records of all expenditures is certain to uncover wasteful tendencies. Keeping scrupulous records turns a spotlight on a problem and allows us to improve.

8.  Risk management.

Before you enter each trade, do you determine where you will exit a position if you are wrong?  Only traders will do this.  Gamblers do not have that luxury.  Having a stop is critical in every trader’s career; because it is your way of saying I am wrong in this particular situation.  In fact stop loss is the only expense that we incur in trading.  Brokerage or taxes are not the real expenses to run the trading business.  Rather our loss is the only expense that we have to pay to successfully run the business. The chaos in the market can drive a trader insane if he does not know how to engage with the market and control the risk.  Proper position sizing is also the essential part of risk management and all efforts need to be done there in order to minimize risk and ensure survival into the market.

In conclusion,

Most people who attempt trading, do it very sloppily.  Many a times they are not even aware of what actually they are doing, whether they are trading or gambling.

You have to be honest with yourself.  If you are day trading and you tend to violate in any of the topics as discussed above, you will fail at trading.  I know that sounds harsh, but it is the grim reality of the market.  Market has a crazy way of separating people from their money when they do not follow discipline and refuse to remain within their limits and act erratically.

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