Tuesday, September 25, 2007

Gambling versus Stock Market Speculation – Some Observations

While on my business trip in Cambodia, I visited a casino in the evenings to observe the psychology and behaviour of gamblers. Most of the casinos in Cambodia are “unregulated”, in that there are no strict guidelines on minimum age (I saw a kid running around in the premises, much to the chagrin of the staff) and no laws governing any “deposit” to be paid. Thus, one could just come and go as they please and observe the actions of the players within the casino. After reading about the casino-like behaviour of stock market punters and speculators, I was admittedly curious about whether there truly were any observable similarities.

It is interesting to observe that a lot of what happens in casinos (whether large or small) is similar. People will (alternately) get wildly excited or extremely pessimistic and depressed, mirroring Mr. Market’s mood swings. By observing the Baccarat table (which incidentally was played with electronic cards and not real physical cards), I was able to see that some men wagered more than a few thousand US$ on one bet, only to have it all blown down the drain. When these people won a few hundred back on the next hand, they became wildly excited and high-fived everyone around them. These are the people who will probably remember their wins rather than their losses. This is quite similar to stock market punters and speculators who usually prefer to talk about their winnings rather than their losses.

People who stay longer in a casino also have a higher tendency to lose, in what is called the “house advantage”. Apparently, the machines, mechanisms and reward systems in the casino are designed to give them an advantage over the long-term, meaning that if you bet consistently then on average you are going to lose out. I do not have the exact statistics for how much you lose per dollar of bet but it can be pretty alarming ! Similarly, stock market speculators who stay too long to enjoy the “party” are also subject to the “house advantage” which is reserved for professional traders. These institutional traders have access to real-time live pricing using powerful terminals and enjoy close to zero commission and brokerage fees when they trade at lightning speed. The average retail investor is thus severely disadvantaged by this, and long-term investing is a way to “beat the house at its own game” as you would smooth out the volatility.

Another prevalent attitude is the tendency for people to form patterns due to observable phenomenon. This was the most interesting observation of all, I would say ! By observing people playing roulette, I noticed that the number “22” had appeared three times in a row; thus prompting punters to predict that the next roll should be “22” or at least an even number. The reality, of course, is that the next number is totally RANDOM; but the lesson here is that people tend to seek patterns and form ideas on how things should turn out because our minds seek familiarity. Compare this to technical analysts who seek to find patterns in historical price data in order to predict future trends. As far as researchers have said, these patterns are similar to a random walk but nevertheless, legions of people keep trying to read the future direction of the market from charts and graphs anyway. The fact that most have failed is the reason why value investing can be so successful anyway.

Thus, to sum it up, the behaviour I have observed in a casino closely mirrors the frantic buy and sell activities seen in stock market rallies and crashes. The punter (speculator) is the one who tends to lose out the most eventually, as he cannot control his emotions and lets frequent over-trading erode any possible gains he makes (through commissions and other frictional costs). It would be wise to learn from the casino (and upcoming IR) in that: the house advantage is always there, if you are so confident of beating it, then you can try, but 95% of traders lose money in the long run.

16 comments:

Anonymous said...

harry here.

being a frequent visitor to casinos, i certainly agree with you on your observations.

your question on the house edge can be answered through many websites. it all depends on the games that you are discussing. e.g. roulette is more than 5% assuming single "0" and one plays only even-odd/red-black bets. baccarat is slightly over 1% i.e. one is expected to lose $1 out of $100 wagered in the long run.

i don't think it is right to compare the "trend" in games like bacarrat and roulette with TA in stock market. TA is, to a certain degree, depending on price movement and volume. People get stuck in buying prices and tend to sell at certain cut-loss prices. this concerns psychology which TA uses to attempt to forecast the support and resistance. The same cannot be said about non-existing trend in games.

In summary, majority of the particpants in casinos and stock markets are mainly driven by greed. they do things with short term profit in mind. greed prevents them from analysing in objective manner. it's kinda funny in a sad way when one loses $ by not doing enough research.

even casino games can be researched i.e. you should know the odds that are stacked against you and the optimal strategy you should use to minimise loss. I play with the expectation to lose in the long run (kinda funny), but i treat it as a price for entertainment, much like that price you pay for a movie ticket. if my real loss is close to the mathetimatical loss, then i'm pleased that my strategy is optimal.

Anonymous said...

http://growmoney.blogspot.com/2007/09/frustrations.html

just want to share with you what a TA expert is going through emotionally in this current market. This is why i prefer FA... less stressful, less second-guessing myself.

sleep tight!

harry

Anonymous said...

I am constantly amused that the guys from opposite camps laugh at each other's strategy. The FA will think TA is crap and vice versa.

Each has a place. FA tells you what to buy. TA tells you when to buy it. If the stock consolidate for 2 months on a base, you are better off waiting for it to jump off the base before buying while using your money to buy other stocks. That is when TA is useful. Keep an eye on that stock until it breaks out of a base.

Many TA practitioner buy crap stocks and say they are TA trader. That is the most amusing part. These are actually suicide traders. The best traders like Livermore are both a TA and FA combo trader. He only buy stocks that have strong earnings and he timed his buys perfectly.

I am sorry for the poor souls out there who think that using TA to buy crap stocks will make one rich.

BTW, Musicwhiz, your blog is among one of the best I have visited, though we are on different strategy. Keep it up.

Ciao,
MM

musicwhiz said...

Hi Harry,

Thanks a lot for your comments, I was actually aware that casinos cannot be 100% compared to TA or chart reading as there is crowd psychology involved in the stock market; thus it is not totally random unlike card games and roulette. Was waiting for someone like yourself to point it out !

Yes I think the odds can probably be found on some website but I didn't really bother to do the research. It's true that if you play very long, then the odds of losing are significantly higher. Thus, it is always better for casino players to exit once they have won a pile which gives them a decent profit. The problem is in the mentality of these casino players to try to win more; these casinos play on punters' emotions ! All I can say is that casinos know human psychology extremely well and they have made a career out of it.

I also agree with you that some people play because of the entertainment factor. They give themselves a certain capital to "lose" and once they lose it all, they leave with a satisfied smile as they have had their "fun". This is quite harmless as long as the usual casino emotions don't come in (i.e. greed).

Cheers, musicwhiz

musicwhiz said...

Hi again Harry,

Thanks for the link, I think it'll be very stressful as well as it involves a lot of research and predicting, not to mention fast fingers and timing. The software also plays a part as I have seen people on forums curse their hearts out when they did not manage to key in their order in time. Altogether, a very stressful thing indeed !

musicwhiz

musicwhiz said...

Hey MM,

Thanks for visiting my blog and also appreciate your compliment. As I have said, it's comments such as yours which give me the motivation to continue blogging about value investing, even though we may be of different wavelengths.

I would agree TA helps you to "time your entry", but as I am not a chart reader I would thus prefer to let Mr. Market dictate a good price to buy into a company. Since all my buys are long-term, I don't use TA for short-term gains either as I consider it too unpredictable (you can, of course, beg to differ on this). Instead, I compute an approximate intrinsic value and use this as a basis to set my margin of safety.

On the point about suicide traders, yes people who use TA to buy pennies and "unsound" companies usually end up with opportunity costs and huge losses (not including a lot of frictional costs). Jesse Livermore was indeed a great trader but too bad he did not follow his rules stringently; plus his untimely demise is also a very sad thing as traders could have learnt much more had he retired a successful, rich person.

Nonetheless, to each his own. I wish you luck in using TA to trade, but I shall stick to value investing as I feel it suits me better.

Regards, musicwhiz

la papillion said...

Hmm, I also find that the FA and TA camps funny. To me, it's just different tools to see the whole picture. None is more right than the other.

I started off with TA, now venturing towards FA, sort of works for me. I guess everyone got to find his/her own method. If it works, well, good!

Thks musicwhiz for blog, i enjoyed reading a lot :P btw, i'm duckula06 from cna forum, recognise me? haha

musicwhiz said...

Hi la papillion a.k.a. duckula06 (wow confusing !),

This posting is not really about TA and FA, I am merely using the casino as an illustration to compare between speculation (which partly makes use of TA to predict prices) and gambling. If you want the low down on FA versus TA, I think one of my previous posts does address that....

Probably there are people who can use TA to their advantage consistently (I haven't heard of one yet, out of the many friends/colleagues I have trading the market); but value investing will guarantee decent returns assuming margin of safety is met with minimal risk. Plus, you don't have to monitor the market like your life depended on it ! Just my take hehe...

Thanks too for visiting...:)

Regards, musicwhiz

Anonymous said...

Hi

A lot of great investors describe investment as an art, Phil Fisher, Charlie Munger, you name it, not for no reason. If TA indeed is a science for pschology, don't see why one can't make wise investment.

"So far as I have been able to observe, this means given sufficient time for fair comparison, say five years, the most skilled statistical bagain hunter ends up with a profit which is but a small part of the profit attainted by those using reasonable intelligence in appraising the bussiness characteristics of superbly managed growth companies." - Phil Fisher.

musicwhiz said...

Hi there,

Phil Fisher definitely had a way with words ! Thanks for the quote.

Regards,
musicwhiz

la papillion said...

Yo musicwhiz!

Swiber have major development news!
http://info.sgx.com/webcoranncatth.nsf/VwAttachments/Att_D29015B728F9637448257362000778A4/$file/PressRelease-Swiber_PVC_VSP_in_cooperation_agreement.pdf?openelement

Entering a cooperation agreements with two state-owned companies to tap oil and gas market in vietnam :P

Happy news :P

musicwhiz said...

Thanks la pipillion, I have seen the news article.

I only think it is mildly positive. It is a non-exclusive agreement which means the Vietnamese parties involved can also work with other companies (it need not be Swiber). Thus, I am cautiously optimistic of them securing business in Vietnam.

Cheers, musicwhiz

Alen said...

Hi,

I tend to agree with your observation. However, although we may argue that using the TA charts to find pattern is useless, there are many market players using it. Thus, it would cause the pattern to become "true".

For example, if the buy signal emerged, many trader which read the signal, would begin buying and thus push up the share price. This, in turn, proves that the chart is "correct".

musicwhiz said...

Hi Alen,

Yes, I believe what you are referring to is a "self-fulfilling prophecy" in which people help to validate something which they strongly believe in. However, if too many people use it, I still think its effectiveness will be eroded over time. There have been empirical studies done which have proven this (e.g. January effect).

Cheers, musicwhiz

Anonymous said...

Ben Graham wrotes: "There is no basis either in logic or in experience for assuming that typical or average investor can anticipate market movements more successfully than the generally public, of which he is himself a part"

musicwhiz said...

Hi Anonymous,

Yes, Ben was absolutely right. Sadly, many people still try (in vain) to predict market directions and the movements of individual counters. As I have said before, share prices are similar to a random walk and there is no empirical evidence of being able to accurately predict stock prices 100% of the time.

Regards, musicwhiz