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Archive for April, 2008

Is Investing Like Gambling? A Rudimentary Question That Requires Further Inspect

April 2nd, 2008 at 02:41 am

A couple years ago, I read an incredible book about MIT students who were recruited and trained to master Blackjack and count cards in casinos (primarily Vegas, but also exotic locales globally) and net Millions of dollars at the expense of the casinos. It was a tale of incredible proportions - college co-eds strapping hoards of cash to their torsos and bypassing airline security, backroom roughing up, exotic disguises and deciept.

I was riding home the other night and heard an interview with one of the actual subjects of the book and they mentioned there will finally be a movie forthercoming titled "21". I wanted to highlight the book here and recommend that you take a read before seeing the movie, as you often miss out in just seeing a movie when it was preceded by a great book. Most of the time, you'll find that movie didn't do justice to the book, but you will feel vindicated in having read it first. You'll also sound cool in front of your friends in dispelling myths and misunderstandings in the movie and you can close with, "The book was better"...(we all hate that guy, I know). Attached are links to the original as well as the book tied to the movie "21":

One might ask, "What does a finance and investment blog have to do with gambling?". Well, there are many corrolaries and takeaways here. I am not one to espouse the belief that "investing is like gambling", which is the mantra of people that don't understand finances and like to relay this to their friends and spouses to assuage their egos.


The similarities are worth considering:

Investing is about numbers. statistics. probabilities. and random variability. So is Blackjack. Blackjack is the ONLY game in the world where players can routinely beat the house. While the house edge is generally about 1.5%, this edge can sway to the player to the tune of 2-3% on certain hands, which can be exploited beautifully. This is a statistical certainty IF you count and alter your bets accordingly, play perfectly with the most optimal strategy and play long enough.

Although the odds are in your favor, in the short term, anything can happen. It's the standard deviation that gets you. If you're an investor with a short time horizon, you should not be fully invested in the stock market. For instance, if you have $50,000 set aside for a down payment on a house later in the year, you should NOT have this money in equities. Similarly, even by employing the optimal strategies and counting methods, the standard deviation of the game is such that over short periods, your odds of winning are about 50/50, but the standard deviation is enourmous. In a given round encompassing a full day, you will win only 2/3 times. That means you may fly all the way out to Vegas, play for 8 hours each day on the weekend and go home losing your entire bankroll.

Deviating from your strategy and letting your emotions take over can have devastating results. Each investor reading this has war stories of buying more of a favorite stock after a major drop thinking, "How could this stock possibly go any lower? This is the stock that I picked and I know it's a winner. I'm a winner! How is my stock going lower!?". We also know the downside of holding too much of our own company stock to which we already have so much vested, yet we continue to hold a disproportionate amount of shares in our employer's stock. Well, likewise, with Blackjack, how many times have you hit on 16 one hand and stayed on another because "you felt there was a face card coming". How annoying is it having the moron at the end of the table cursing out each person for ruining the run by not playing the hand right. Does he praise them for playing the hand wrong when it benefits the table by forcing the dealer to bust? People get emotional and do not act rationally or objectively when investing and when gambling. In each case, the best outcome cannot be achieved, because you're deviating from the optimal strategy, be it stock diversification, minimization of commissions, avoidance of buying high and selling low, or in Blackjack, giving the house an additional edge by not adhering to the optimal player's strategy.


So, I'd like to dispel any rumors that I've made the proverbial simplistic statement that, "Investing is like Gambling". After all, when you leave the casino, you don't own shares in the casino still. But, there are lessons to be learned and employed in each that cannot be ignored.