Investing as Roulette: A Gambling Analogy

A recent conversation with a family member sparked my interest in how previous generations view investing money in the market versus the older and more traditional wealth preservation practices of owning property and socking money away in a savings account. After reaching out to a larger audience of friends and colleagues for their perspectives I realized that there are a lot of people out there that view investing in stocks analogous to gambling. To be perfectly honest I can definitely see the merit in that argument, however there are a few key differences in investing versus gambling.

 

 

Let’s take roulette as the example for gambling as it is one of the two popular gambling games with the best odds (craps of course being the other). In roulette you have a wheel with 36 possible numbers to place bets on, you also have the added ability to bet thirds or half of the board, pairs, odds or evens, etc. The added wrinkle in roulette is that there is a single zero or double zero on the board that slightly tips the odds from 50/50 into the favor of the house. For this analogy we will simplify the game and say that you can only bet on black or red, you can bet whatever you wish, the numbers correspond only to the colors and the remainder of the game mechanics are the same.

 

Examining our now severely simplified version of roulette let’s examine the variables that determine whether we win or lose:

  • You have the ability to bet on the colors black or red (analogous to a long or short position in a stock)
  • You have the ability to bet whatever you want on either color (analogous to the amount of money you can invest in a stock)
  • The roulette wheel spins and a ball is placed on it that will randomly land on either black or red (analogous to unknown market movements)
  • There is a dealer responsible for spinning the wheel and dripping the ball (analogous to the CEO or board if directors in this example)

 

There you have it, a game where you can spin the wheel and hope for either a positive or negative outcome which will be proportional to the amount of money you risked or “invested” in the round. You can either win or lose in roulette just as you can with the market… but not quite.

Looking at the same simplified variables above from a market realistic perspective there are some details that need to be accounted for:

  • Who manufactured the roulette table? What is the history of defects? How many are deployed globally? Historically, what color do they favor?
  • Who is the dealer? Is he right handed or left handed? How fast does he spin the wheel? Etc?
  • Who are the other players at the table? How are they betting?

The above factors are analogous to factors in fundamental analysis in the investing world. Access to the past performance of the company, access to the historic sales and performance numbers, access to past product/services successes and failures, access to previous acquisitions, access to the trading activity of inside and outside investors are all a reality and all of that information can be researched and analyzed before making an investment decision. Sound fundamental analysis attempts to find the true “value” of the investment and will help you to understand when and how much to invest.

 

  • What has been the ratio of black to red wins for the last day? Week? Year?
  • How many reds in a row have their been up to now?
  • Who is betting on what right now?
  • What is the current trend of wins?

The above factors are analagous to factors tracked in technical analysis in the investing world. Technical analysis seeks to identify and follow trends and will help determine when are the best times to enter and exit an investment. For example, let it ride on black for the next three turns then bet on red.

 

  • What is the ambient temperature in the room? How will that impact the speed of the wheel spinning?
  • How does the dealer play towards the last hour of his shift?
  • What color is favored on Wednesday based on past data?

The above questions would be considered quantitative analysis in the investment world. Quantitative analysis combines factors from both fundamental and technical analysis with added points from historic data and attempts to predict the future performance within an acceptable level of certaintity. Quantitative analysis can be exceptionally complex and is often used to program computers that can analyze and react to changes in input in real time.

 

Fundamental, technical, and quantitative analysis combine to predict the level, timing, and frequency of investment in the real world. A successful investor may choose one or many types of analysis to use before making an investment. So is investing still gambling? While the end result is still investing money into an entity that may not grow or “win”, effectively making a bet, the fact remains that almost every variable is available to analyze before making an investment in the real world which is the true difference between gambling and investing. Gambling is betting blindly on an outcome, investing is betting based on thorough analysis of the bet, players, game, and other variables.