Is trading in the stock market just a form of gambling?

Every time someone hears that I work in the stock market, their first few questions are invariably the same. If I have to categorize the questions then they either assume I know exactly why the market is going up or down and where it is headed in the future or they assume I am just gambling and wasting my time and trying my luck in a zero-sum game.

Although I do not know much about gambling, I can surely tell you what trading is and what trading isn’t based on my 3-year full-time experience in trading.

Let’s start with understanding why trading in the stock market is often confused with gambling.

Possibility of quick money

There are so many stories of genuinely successful traders who have made wealth by trading. And who doesn’t want quick and easy money? But, is trading really like Las Vegas casinos which can make you a millionaire or a pauper in a single day? Probably not, it takes much more time and effort than that; both to make and to lose money. And then there are these crooks who pose as advisors and try to lure the Common Man into trading, promising quick money. They share screenshots of good winning trades (may or may not be their own) and promise very high returns within 1 or 2 months. Beware of this classic trap! Any quick money is not sustainable- both in casinos as well as the stock market.

The game of probability/game of chance/luck is an important factor

Yes, trading is indeed a game of probability. Any stock can have one of three movements- trendy up, trendy down, or rangebound/sideways. So, let's assume the probability is 33% for each movement. At the risk of over-simplification, the difference between successful and unsuccessful traders is the ability to increase the probability to at least 50% by eliminating at least one of the three possible movements. It's easier said than done.

Yes, there is also luck involved in having successful trades. For e.g., if you trade on pattern breakouts, there is always a chance of false breakout signals resulting in losses despite correct identification. But can you rely solely on luck in trading? The answer is No.

High-risk, High-reward

Yes, indeed trading is high-risk, high-reward. You can be ‘all-in’ all the time and lose it all at once. But again, that’s the difference between successful and unsuccessful traders, I guess. Traders who are consistently successful will either take measured risks or go ‘all-in’ only when their estimated probability of success is greater than 60-70%. Know your risk appetite and in that primarily your ability and willingness to bear loss before venturing into trading.

Let’s now understand why trading isn’t gambling.

There is an underlying value for the stocks

Unlike a deck of cards which can be drawn at random, stocks cannot have a random price. The stock price movement although looks like a random walk, it follows the principle called ‘mean reversion’ i.e., the price comes back to its average. Furthermore, the mean of the stock price closely tracks the value of the stock. The value of the stock in itself is determined by multiple factors such as the revenue generated by the company, the company’s earnings potential, debt in the company, working capital management, volatility of the stock price, country’s growth, sector growth, easy access to capital, government policies, geo-political scenario etc. In short, there need to be at least a few known and measurable reasons for the stock price to go up/down significantly from its current level, otherwise, any rally will not be sustainable.

Trading is skill based

Can you drive or cook or stitch without training? No, right? You may have a natural talent in it, yet would require some training and experience. Such is trading. For trading, you need skills ranging from identification of market trends, pattern recognition, understanding of fundamentals of the company, probability calculation, strategy building, control over emotions and biases, continuous tracking, etc. With time and effort, you can acquire all these skills and become a successful trader.

Trading cannot solely rely on luck

As with all businesses, there is uncertainty and reliance on luck when you trade. Even the best trading strategies do not have a 100% probability of success. But if you want luck to be your primary driver instead of focusing on building good strategies, then only God can save you from losses and keep your profits consistent.

Proper risk management can be done and needs to be done

I think the ability to do risk management is the biggest difference between gambling and trading. Although there is a very high risk when you trade in derivatives, even the biggest risks can be managed. Some common ways of risk management include hedging, optimal margin utilization, stop loss orders, understanding the fundamentals of the company well and tracking the performance of the stock you trade in, etc.

My humble opinion is that rather than blindly entering into trading or blindly shunning trading as ‘not my cup of tea’, I hope everyone can spend some time trying to learn and acquire the skills required for trading and investing successfully. For all you know, if you learn the skill properly, it might be more rewarding than your current job.