Proponents of legalized gambling of one form or another are wont to call “the law” a hypocrite by pointing to the fact that governments that proscribe gambling in casinos, at racetracks, or in private homes are the same governments that endorse the existence of the stock markets. Indeed, they are the same governments that invest pension funds in the markets, the same governments that go to the markets for bonds to use for various public projects. If it is good enough for the government, why will the government not allow others to play games of chance as well?
There can be little debate about whether stock market and bond market trading (stocks and bonds are referred to as securities) involves some of the elements of gambling. Persons put up something of value for consideration; that is, they advance money into the market. They do so with the hopes of achieving a prize; that is, a financial gain. And, as with gambling, there is some risk involved. Yet although all of these elements of gambling may be found in the market, and although some people who enter the market do so with the same inclinations as people who wager on the green felt tables of Las Vegas, there are material differences between betting at a casino, at a race track, or on a lottery, on the one hand, and putting your money down on a commodity – bond or stock – in the market, on the other hand. The differences are so substantial in a material way that I choose not to give any in-depth treatment to stock markets. Nonetheless, I feel that a clear delineation between market investments and wagers at games of chance should be offered.
Those who would think that Wall Street is a casino must also think that any business venture is gambling. Yet stock investments, bond investments, and other commodity transactions are vehicles for the creation of wealth. By investing, the stock-purchasing public is saying it has confidence that certain products and services will be desired by others and will serve to meet demands of a public. A bond purchase or the purchase of an initial public offering (IPO; the first sale of a stock by a company) does indeed transfer money from individuals to entrepreneurs. Most stock purchases, however, are on a secondary market, such as the New York Stock Exchange; that is, people buy and sell stocks, and money is transferred back and forth between the buyer and seller without any money going to the company. Nonetheless, if the stock performs well it benefits the entrepreneurs in many ways. First of all, such a performance creates an incentive for recruiting talent, as the companies invariably give stock options to top managers and perhaps to all other employees as well. The company takes some stock and holds it in reserve, putting a current price on it as of the time it was put into the reserves. The company then tell the employees that if they stay with the company for some period of time, they may buy the stock from the company at that predetermined price. If the value of the stock goes up, the employees of the company gain wealth, and their loyalty to the company is enhanced. New employees can more easily be recruited if the stock values are rising. A second benefit of a successful stock, in terms of its market price, is that it makes it much easier for a company to issue new shares, through an IPO and hence recruit more capital for corporate projects.
But let us go back to the individual investor. The investor may or may not give close study and scrutiny to the purchase of a stock. After all, not all of us have the time, energy, or financial acumen to make the best choices on the market. For a fee, however, we can find persons with expertise. On the other hand, we may want to play a hunch. Or we may just wish to take a dart and throw it at the New York Stock Exchange or National Association of Securities Dealers Automated Quotations (NASDAQ) listings in the Wall Street Journal. Is this not just like going to Las Vegas and betting on a red seven on the roulette wheel? The answer is “No, it is not”. The roulette wheel, the craps table, the blackjack game, the lottery, and the horse race are all zero-sum games. For each set of winning numbers there is more than that number of losing numbers. Indeed, the casino game is not a zero-sum game, but by necessity must be a negative-sum game that casts the players as a collective into a losing position over any period of time except a very short run.
Although the stock player going through a broker must give a commission for a sale, that commission can be considerably less than 1 percent of the value of the purchase. This compares favorably to the best odds one can get at a craps table and is substantially better than the casino’s brokerage fee of 2 to 20% on other games. It is far better than the predetermined house edge of 20% on the typical horse or dog race and even much better than the 40 percent to 50 percent commission the lottery player pays the government for the right to enter that market. The casino games are rigged against the players as a whole, and this can be justified only on the basis that they are selling an entertainment value for the play experience. Wall Street does not exist to sell entertainment value in trading.
The stock market can very well be a positive-sum game in which every player can be a winner. Indeed, through the 1990s the substantial majority – perhaps 90% or more – of the investors were winners. They did not take their wins away from anyone; they did not win against other stock owners; they did not win against the companies in which they invested. They won because the companies in which they invested created wealth through their entrepreneurial activities. They made products out of raw materials and labor and ingenuity, and when the products were sold, the public bought them at a price considerably higher than that of the sum of the input investments into the products. In turn, this gave greater value to their shares. Ah! But it is true that everyone can also lose. Witness the sad days of October 1929, or October 1987, or more recently April 2000. Here then is another difference between the casino and Wall Street. In the casino the roulette wheel stops, the dice stop, the reels of the slot machine stop, the Ping-Pong balls of the bingo or lottery game quit floating to the surface, and the horses cross the finish line. The game in terms of time is finite. It ends, and someone has to pay the piper right then and there. But until a company goes fully bankrupt – the bankruptcy laws, with their chapters 9 and 11 and in the worst cases chapter 7, use the lucky numbers of gambling to indicate the status of a company that has failed – the stockholder can hold on and wait for a better day. The stock market may be a game, but if it is, the game is continuous, and it need end only when the investor decides to make his or her final sale. It hurt to receive my portfolio statement in May 2000. As I am for the most part a passive investor, however – I have a broker, and I have a pension fund that handles my investments – I just sat still with a small frown. A smart investor could have grabbed at the opportunity – because just as in poker, every day is a winner and every day is a loser on the market, but I just sat still. My pension fund was back on target by the end of the summer of 2000, and my other investments were beginning to approach their March 2000 levels – at least they were way ahead of the 1998 and 1999 levels at which I had made my purchases.
Who knows what tomorrow may bring? If we look at history, we can see only good results. The cumulative stock exchange has never gone downward for a full decade. Indeed, for a ten-year span, the stock market since its beginnings in the nineteenth century has never moved upward less than 10.5%. That was the gain during the Depression years of 1929 to 1939. There is no secret to success on the market. To be on the safe side, however, one could suggest that investors purchase index funds that go up and down with the full market – for instance, a fund consisting of all the stocks on the New York Stock Exchange or one of the 500 funds – or the thirty leading stocks upon which the Dow Jones average is based. There is a fund (with the symbol QQQ fund) that includes the top 100 NASDAQ stocks (newer stocks that have become identified with technologies of the computer age).
If one gets in the mood to throw darts and really feels like taking a risk, however, one can buy options. These are purchases of the right to buy or sell a stock at a certain value at a time 30, 60, or 90 days in the future. Here, unlike other stock investments, there is a time certain when a transaction must be completed, and although the options may promise great rewards, they also carry risks of great losses – such as the loss of the total investment, a risk that is very rare for a stock purchase. Even more risky is a practice that has become more popular in recent years as computers have allowed investors to have immediate information on the movement of prices of stock. It is called day trading.
Day trading is the act of quickly buying and selling stocks and bonds throughout the day. At the end of the day, the day trader usually owns no securities. Indeed, when he or she places an order to buy, there is a period of time (usually three business days if he or she has an account with the broker) to complete the purchase by providing funds for the security, during which time the investor eagerly seeks to make a sale of the security, because it is unlikely that he or she has the actual funds to cover the initial purchase. The day trader is not a professional and typically has little or no formal training in the financial markets. He or she is an amateur, usually working without any supervision and using his or her own money to buy and sell the stocks, futures, and options. The day trader may sit in front of a computer screen, watching the price movements of the stocks he or she is trading, hoping to make a quick “killing” with the slightest movement upward of the stock during the day.
As an example, consider that AT&T is selling for $60 a share. The trader places an order for 1,000 shares, hoping to sell it for $60.125 (60 and one-eighth) if it moves. This very small movement is the smallest movement publicly listed on the exchange, which measures prices in eighths (although an exchange can be at the 1/32th of a dollar value). The smallest movement is soon to be changed from eighths to tenths. If the investor sells the stock, the quick profit is $125. By making similar moves throughout the day, the day trader can achieve some very nice gains.
Several factors work against repeated success on these ventures, however, and make day trading quite similar to gambling. For one thing, there are commissions that must be paid when purchases and sales of stock are executed. Even at a low rate of $8.95 from a broker who will handle the transaction without offering advice, the buy and sell will cost $17.90. This commission is paid, win or lose, whether the stock goes up, stays at sixty, or descends in value. For each dollar the stock goes down, the trader loses $1,000 plus the commission. Another psychological factor against repeated success is that the trader has to hold his or her breath waiting to see whether he or she makes a sale before the payment is due—it is unlikely the day trader actually has the $60,000 for the purchase.
Another cost to day traders, who may gather at a broker’s office, is a fee to use computers there. Also, under the arrangement, the broker is not selling advice but rather only a space to work. A broker who works with an ordinary investor seeks to find value in the market, because he or she too will be receiving a commission – a little higher than the $8.95 charged by the passive broker – and wants a lot of repeat business. The broker has an incentive for performing well. On the other hand, a day trader and a gambler are both alone with their money and the roll of the dice on the computer screen. Each day the gambler trader must prove his worth by successfully trading to make a profit or by getting out of the deal with as little a loss as possible.
Often if losses begin to accumulate, the day trader’s money reserve begins to dwindle. Possessing some of the same traits as a pathological gambler, the losing day trader will seek funds from every possible source for his games. A brokerage firm, like a casino, may actually loan the day trader money for transactions and, in a sense, help him or her string out the losing experience. The loans have to be secured with the day trader’s stock account assets. Losing these, the trader turns to his or her home mortgage and other hard assets to bail himself or herself out. Often day traders do not get out in time, and they start downward on the same slippery slope as the problem gambler.
Over the course of time, the stock market performs quite rationally. Long-term trends have been solid. In the short run, the market can do many irrational things. Stocks of established companies could be expected to increase in the long run if the company has a record of successful performance and has value behind the price of the stock. In the short-run, however, prices can take quick dips and rises that may be totally unexpected. The inability to live with these wild short-term swings in price has ruined many a day trader. The market can be beaten, but it takes patience, and actually there is no one to beat – as there is with the casino.
Spurred on by greed and promises of great riches, day trading has become the modern-day California gold rush. Unfortunately, very few day traders make money – or perhaps this is fortunate, because day traders are not playing the game the way it is supposed to be played. They are not investors. Still, no one really likes to lose money, and fewer accept losses when they realize that their own bad judgment caused them. Consequently, day traders have been known to irrationally blame others for losses. This happened in Atlanta, Georgia, during the summer of 1999. A day trader faced with losing everything, including his business and his house, blamed the manager of a brokerage house where he did his trading. He felt that the manager of the firm that specialized in giving services to day traders should have warned him to be more vigilant. He also was angry with other day traders for not sympathizing with his plight. He went to the firm’s office and began shooting people. After a murdering rampage, he committed suicide.
A long-term, patient investor should be secure in feeling that the stock market will be kind to him or her. A short-term day trader may make a killing, but it is just like the pathological gambler’s first big win. Losses are sure to catch up and overtake wins, if he or she does not get out quickly. There is only one difference between day trading and gambling: In Las Vegas the gamblers get free drinks.
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