Is Investing in the Stock Market Gambling?
A friend of mine, with the trading alias of the Lone Ranger, told me that her relative said investing in Penny Stocks is gambling.
By definition, Gambling is the activity or practice of playing a game of chance for money or other stakes.
The sentiment that investing in the stock market is gambling is often expressed by people who believe that making money by purchasing stocks is unlikely. The result for most people will be a loss.
The points above are reflected in the paper titled, “Who Gambles in the Stock Market?” by Alok Kumar.[1] In the paper, Kumar identifies lottery-type stocks by using lottery tickets as a reference. Lottery tickets have very low prices relative to a high potential payoff. They have a minuscule probability of a huge reward and a huge chance of a small loss.
To identify lottery-type stocks, Kumar organized stocks with low prices, high volatility, and investor sentiment skewness into the stocks with lottery-like features category. In other words, there may be high volatility of oil company security due to pipeline breaks. This may result in an adverse price move. Conversely, if a large oil field is discovered, this may cause a positive price move. The result is the high volatility of the stock price.
When these events happen for a particular company more than once, there may be a skewed perception of the company unrelated to the company’s fundamentals. People may invest in them thinking that the large moves will happen again, especially if it’s a low priced stock, AKA Penny Stock.
Kumar concludes that the characteristics of lottery-type stocks are that they have low market capitalization of 31 million or below, low institutional ownership at 7.35% or below, and low liquidity. These stocks are young, have low analyst coverage, significantly higher volatility, skewness, and low price per share.
Remember the sentiment we discussed earlier regarding the likelihood of losing money?
According to the Tradeciety website:
“Profitable day traders make up a small proportion of all traders – 1.6% in the average year.”[2]
That doesn’t sound encouraging, but my experience indicates that this may be a problem with trading frequently. Many famous investors have made money through the long term buy and hold investing, such as Warren Buffett, Jack Bogle, John Templeton, Peter Lynch, and Benjamin Graham.
I have found that the market has something going for it that favors long term investing. This may end someday, but historically the market goes up over time and always recovers from a crash. In my book Crash Proof Your Investment, I developed a historical histogram chart that shows its favoritism of a profitable return.
The graph shows that the market has positive returns more frequently because the bulk of the graph’s bars are above 0 percent annual return. The market is skewed! Five percent, ten percent, and fifteen percent annual returns are the most frequent.
A more familiar chart is the one shown below:
The trend over 100 years is undoubtedly up. The most significant disturbance in the trend is the crash of 1929. It was the most disastrous crash in American history, accounting for its aftereffects—a 12-year Great Depression followed, which affected most of the world.
Despite the 89 percent decline, in the long run, the stock market recovered.
Finally, from the paper by Kumar, four-factor models for the stock market return are mentioned. Investopedia explains that the results of the Fama and French model:
“Fama and French highlighted that investors must be able to ride out the extra short-term volatility and periodic underperformance that could occur in a short time. Investors with a long-term time horizon of 15 years or more will be rewarded for losses suffered in the short term. Using thousands of random stock portfolios, Fama and French conducted studies to test their model and found that when size and value factors are combined with the beta factor, they could then explain as much as 95% of the return in a diversified stock portfolio.”[3]
So as you can see from the Investopedia article and the work of Fama and French (Nobel laureates), long term investing offsets short term losses that a day trader or short term trader might experience.
In the book Intelligent investor, which is one of the seeds of Warren Buffett’s massive fortune, there is commentary from Zweig’s section that says
“Like casino gambling or betting on the horses, speculating in the market can be exciting or even rewarding (if you happen to get really lucky). But it’s the worst imaginable way to build your wealth. That’s because Wall Street, like Las Vegas or the racetrack, has calibrated the odds so that the house always prevails, in the end, against everyone who tries to beat the house at its own speculative game.
On the other hand, investing is a kind of a unique kind of casino—one where you cannot lose in the end, so long as you play only by the rules that put the odds squarely in your favor. People who invest make money for themselves; people who speculate make money for their brokers. And that, in turn, is why Wall Street perennially downplays the durable virtues of investing and hypes the gaudy appeal of speculation.”[4]
In summary, purchasing particular securities resembles gambling. The stocks have lottery-type features and tend to be, but are not limited to, some penny stocks. On the other hand, the buy and hold investing strategy of non-lottery like stocks is likely to be profitable with historical evidence to back it up.
That’s all for now; good luck with your financial goals,
Dr. Paul Keller.
#stocks #stockmarket #investment #investing #realestate #trading #dalio #minervini #warrenbuffett valueinvesting #author #financialmaster #habits #stockmarketcrash #rentalproperty
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Notes:
[1]Kumar, Alok. “Who Gambles in the Stock Market?” The Journal of Finance 64, no. 4 (2009): 1889-933. Accessed September 14, 2020. http://www.jstor.org/stable/27735154.
[2] https://www.tradeciety.com/24-statistics-why-most-traders-lose-money/
[3] https://www.investopedia.com/terms/f/famaandfrenchthreefactormodel.asp
[4] Benjamin Graham, Intelligent Investor.
Bibliography:
Graham, B., & Zweig, J. (2003). The intelligent investor: A book of practical counsel. NY, NY: HarperBusiness.
Hayes, A. (2020, March 05). Fama and French Three Factor Model Definition. Retrieved September 14, 2020, from https://www.investopedia.com/terms/f/famaandfrenchthreefactormodel.asp
Kumar, Alok. “Who Gambles in the Stock Market?” The Journal of Finance 64, no. 4 (2009): 1889-933. Accessed September 14, 2020. http://www.jstor.org/stable/27735154
Rolf, Witbooi, Mataruse, M., Sm, Anonymous, Burguet, M., & Ahmad. (2020, April 10). Why Most Traders Lose Money – 24 Surprising Statistics. Retrieved September 14, 2020, from https://www.tradeciety.com/24-statistics-why-most-traders-lose-money/
source https://drpaulkeller.com/stock-market-gambling/
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