It’s time to stop comparing the stock market to a casino

The long-term return profiles of investing in the stock market and playing at a casino are completely inverse. Comparing them does a disservice to the approach that investors should take, and can result in a short-term speculative trading rather than long-term investing and capital growth.

The Latvian version of this article is available in print in the March 2021 issue of Forbes Latvia.

Stanley Druckenmiller is one of the greatest investors of all time. His success has been founded on a fairly simple strategy: preserving capital and riding big wins. Over 30 years he averaged returns of over 30% without a single down year. Legend.

Druckenmiller tends to hold concentrated positions that reflect different ‘plays’ on his overriding market thesis. As he likes to say “put all of your eggs in one basket and watch that basket very closely”. He is not afraid to take losses, because he knows that in the future the market will offer him the opportunity to make his money back and more. He also uses considerable leverage, but not to point of no return. Again, preserving capital is key. The market will give you opportunities. Your job is to avoid mistakes.

Druckenmiller’s astounding investment success has absolutely nothing in common with a traditional buy and hold investing strategy. In fact, it has much more to do with the sort of returns you see when someone is winning big at a casino.

So let’s just get out there and ask the question that everyone wants to know: is investing in the stock market like gambling at a casino?

The typical response from a respectable portfolio manager would be to immediately disassociate the stock market from games of chance, and say something that sounds intelligent about the vital role that financial markets play in the world economy (which is true…). People don’t usually challenge this type of response, but most likely leave the conversation thinking “yeah right, it’s a total casino.” They just don’t say it.

I am not going to be one of those ‘respectable’ portfolio managers.

So here it goes: yes, the stock market can be very much like a casino. But it is far more interesting and lucrative. Moreover, much of what you might have heard from experts about investing in stocks is wrong, and is not helpful in building long term wealth. So here we go.

Once upon a time, gambling at a casino used to involve dressing up nicely to go to a beautiful establishment to place your bets. Similarly, you used to have to show up in polite attire at brokerage offices in stately buildings to buy and sell shares. Look around any major European capital. Casinos and stock exchanges tend to be amongst the most impressive buildings. One was meant to draw you in for pleasure, the other built to assure you of the respectability and inherent virtue of commerce. Pageantry and gravitas.

These days you can gamble on casino websites from the comfort of your own home in your pajamas. So too with online trading. Both are perfect channels for the online world. Gambling and trading both activate the brain’s reward system and release the hormone dopamine. So does shopping, social media and sex. And it should come as no surprise that much of online world caters to these powerful impulses. Some of the finest minds of our generation are trying to figure out how to get people to reduce the number of clicks it takes to purchase something online. Can we blame casino operators and brokers for doing the same?

So yes, our body’s chemical signaling system tells us that both gambling and trading are fun, and veer us towards compulsive behavior. Casino operators have long recognized this, and have done everything possible to keep the dopamine flowing. Many brokers still try to limit the risk that inexperienced investors can take online, but many new trading apps such as Robinhood in the US, and eToro and Revolut in Europe are making it cheaper and simpler for investors to begin investing on line. Unfortunately, in the case of Robinhood, they have made it extremely easy for inexperienced investors to access margin and engage in extremely risky trades with low odds of success, but high payouts. They claim to be democratizing investing. This is nonsense. True democracy entails having inalienable rights protected by law, not simply giving people access to potentially hazardous materials and pretend like you are doing them a favor.

Building a strong society – and economy – entails teaching and taking responsibility. So, no, I call foul on them ‘democratizing’ investing, but lower barriers to entry to start to invest in the stock market is a very positive trend, and an opportunity to begin to change the way the broader public perceives and invests in the stock market.

Most ‘experts’ tell people that are new to investing in stocks to only ‘play’ with they can afford to lose. It is about time we stopped this sort of infantilizing advice, because it simply reinforces the perceived parallel between gambling in a casino and trading, and, in so doing, directs attention away from what we should be focusing on and encouraging: real investing. This does potential investors a great disservice.

Other than triggering dopamine and demanding that you take responsibility for your actions, the stock market could not be more different than a casino, and we need to stop approaching them both with the same ‘strategies’ and mentality.

Casinos feature games of chance with set odds that ultimately steer your money to the casino’s safe. In the long term, the house always wins. If you are a responsible person, you acknowledge this and gamble anyway. It’s a little bit of excitement, and as long as you can afford what you lose, everything is fine (I will not get into the topic of mental health and addiction, but it is very serious and should be dealt with by seeking professional help). Given the house edge (ranging from 1% on black jack for the average player to up to 20% for slots), the casino will encourage you to play as much and as long as possible so that their mathematical advantage can compound. They are profit maximizers, not a charity, and make money from numerous finite games infinitely repeated. Casinos compress time to take advantage of a small constant edge. The longer you play in a casino, the higher the odds that you will lose.

In the stock market, the opposite is true. The longer you invest in quality stocks, the higher the chance you will make money. Not only that, the more you invest, the more your money will compound and grow over time. For casinos, time and consideration are the enemy. The market on the other hand gives you all the time in the world and lets you choose how much and how often you would like to invest.

So why do we keep giving people the same advice about stocks and gambling, when we should be teaching responsibility and the power of compound returns instead?

Rather than telling new investors to “invest only what they can afford to lose” we should be teaching them more about markets, how to capture positive convexity though compound returns, and about historical long-term gains in the stock market, rather than highlighting periods of market volatility. The advice we should be giving new investors should be somewhere along the lines of “invest as much as possible and never put yourself in a position where you are force to sell”. If we do this, we will encourage a new generation of investors that understand that time is on their side, and that excess returns in the market come from analyzing and acting upon opportunities in the market that give you higher odds of success, not ‘gambling’ or simply following the crowd.

Successful investing is not easy. It is easy to get distracted, and there is a natural compunction to try to accelerate returns. However, the longer you take investing in stocks seriously, the more you will learn, and the more lucrative it will become. You might not reach the level of Stanley Druckenmiller, but you should do very well for yourself. It just takes time and effort. Most things in life that are worth doing require a high level of commitment – successful investing is no different.