Gambling Vs. Trading – Same Difference?

Earlier in the year as I was reading Scott Patterson’s “The Quants”, a book chronicling how some of the most successful quantitative traders got started, a glaring similarity among all the quants was evident. The quants were first obsessed with gambling and how to use math to beat the dealer; the same quants later realized that Wall Street is the biggest casino around and applied what they learned from gambling and math to make billions from themselves.

It took the quants a little more than a glance to call the street a giant casino -<strong> but were they right?</strong> Is <a href="//www.wallstreetoasis.com/finance-dictionary/trading-overview">trading</a> just an institutionalized form of legal gambling, or should it be esteemed with respect normally devoted only to higher things of refinement and social value?

I hear this debate nag on quite a bit between friends and classmates, but I don’t think people approach the question correctly because they fail to properly distinguish what it means to be a trader vs. a gambler.

<strong>A gambler plays with his own money, a trader plays with other people’s money (aka OPM).</strong>

I would include day traders and anyone else jockeying a high turnover portfolio without hedged positions in the gambling camp because as they grind their savings to sawdust, they are only accountable to the guys on the other side of the table – the house.

Traders, on the other hand, are bounded by their agency relationships which are (hopefully) structured to drive rational behavior. While gamblers simply base their <span class='keyword_link'><a href="/resources/skills/accounting/profit-and-loss-pnl">PnL</a></span> on the net change in assets, traders derive returns based upon <em>how</em> profit is made. The how is based upon meeting specific investing goals (return, asset class, tax effects,..) under specific limitations (risk profile, sector selection, market exposure, ...) set by the capital relationship at stake.

Do some gamblers think they are traders? –Sure. In fact, the real test is tied to risk aversion. Gamblers love to ride their winning streaks, take chances, and double down on losing positions.  Traders are generally obligated to rebalance their winners, hedge uncertainty, and eliminate bleeding positions after a predetermined level.

As a result, the successful trader will be able to live another day as long as he remembers not to gamble. As for the gambler, well let’s just hope he gets to keep his house.

But what about the quants, haven’t they taken a gambling stance towards <a href="//www.wallstreetoasis.com/finance-dictionary/trading-overview">trading</a> since the start? Yes, somewhat, but the quant doesn’t view risk taking in the same was as the gamblers or traders. Unlike the trader, quants tend to stick by their models and positions even if they are bleeding red because the math <em>doesn’t lie</em>. And unlike all humans, the quants program emotion out of the equation.

So what is your take on it? Gambling? Trading? Math? Are you down with OPM?

EDIT: Apologies for the grammatical errors in the original post. *