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Gambling vs. Investing: Casinos and the Stock Market

Written by Guest Contributor - 32 Comments

This is a guest post from Dylan Ross, a Certified Financial Planner and owner of Swan Financial Planning, LLC, a registered investment adviser in New Jersey.

I often hear some variation of the question, “What’s the difference between the stock markets and casinos?” So, I’ll share my typical answer…

While there are several small similarities between casinos and stock markets, there is one large difference. If you go to a casino, buy in, never place a single bet, and then cash out, you receive the same dollar amount you bought in at, regardless of when you cash out.

Now imagine if casinos valued their chips based on how well the casino as a whole is doing. Over the course of a day, the value of those chips might increase or decrease, but let’s say that over time, the increases tended to exceed the decreases. This is more like what has happened with the U.S. stock market.

With the stock market, you can buy into the market as a whole using a broad market index fund, never make a single “bet,” and then cash out at some future point, with the idea that over time the value of your investment can grow along with the market if the market continues to grow.

At the casino, players place bets with the hope of winning (walking away with more than if they never bet at all). In the casino, that would be leaving with any amount greater than what they came in with. People try to do this because they feel lucky, skilled, or believe they have some kind of system.

In the stock market, people trade to try to “win” (walk away with more than if they didn’t trade at all), but in this case a “win” would mean leaving the market with more money than if they simply bought in and didn’t make any trades. People try to do this because they feel lucky, skilled, or believe they have some kind of system. The traders in the market are really not that different from the gamblers in a casino.

In both cases the odds of winning (adding value through betting/trading) are against you, but at least the market lets you participate in its overall growth potential just by being there. Trading, like casino gambling, is a negative-sum-game. For every dollar won over the market, one must be lost; furthermore, whether you’re a winner or loser, you must also pay financial intermediaries.

To summarize, both stock markets and casinos provide the chance to try to do better than others by making bets. Neither have odds that favor a strategy of trying to do better through making bets. Stock markets give you the potential to participate in their growth without making bets. Casinos do not.

Published on February 25th, 2008
Modified on June 10th, 2009 - 32 Comments
Filed under: Saving & Investing

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32 Responses to “Gambling vs. Investing: Casinos and the Stock Market”

  1. 1
    KC Says:

    I live near the second largest gaming community in the country, and I’ve made a few trips down there. But I very rarely left with more money than I went there with despite being a fairly knowledgable blackjack player. I’m also an investor and there have been times when I’ve likened the stock market to the casinos (those were the bad days!). But investing in the market is not gambling. If you actually do your research and time when you go in (like now) and take your profits when you can (like prior to last summer) – you can make money very consistently in the market. Casinos, unless you have an incredible ability to count cards, you are taking a pure gamble. And in gambling the casino ALWAYS wins. But there are plenty of people in this world that can attest to “winning” in the market. If I were a betting person I’d take the stock market any day!

  2. 2
    Jesse Says:

    Arrrg – thats how I feel when people try to compare the two. It honestly drives me absolutely crazy…I can’t add much to what you said, but I will say its in my top 5 pet peeves as far as finance related things go.

  3. 3
    Dividend growth investor Says:

    Actually you can buy the casinos on the stock market, but you can’t buy the stock exchanges on the casinos :-)
    In addition, i haven’t met a single person who bought chips, held onto them for 30 years and then was able to retire.
    When you deal in stocks you do deal with uncertainty and probabilities, but at the end of the day you are investing in businesses. And you are not reall “gambling” but you are stimulating the economy by allocating your resources into sound investment vehicles.

  4. 4
    Fiscal Musings Says:

    I’m glad I’m not the only one who didn’t concur with what was said here. I mean, honestly, likening a stock trade to a bet at the roulette wheel…?

    It’s also far too simplified to talk about a negative-sum game. Without the financial intermediaries, by this thought it would be an even sum game. If that were actually the case, then the market as a whole would never go up, and that is what is being advocated as a sound investment, the market as a whole.

    The market as a whole can go up because more and more money is put into the market over time as people continue to invest and new people start to invest. The market can go down when people take their money out of the market.

    This “negative-sum” or even-sum game thing is a little too simplified.

  5. 5
    Kyle@amateurassetallocator Says:

    I have never heard this explained so simply and elegantly. Bravo. Couldn’t have said it better myself.

  6. 6
    Ron@TheWisdomJournal Says:

    Invest in casino stocks! The house ALWAYS comes out on top!

    Seriously, traders are not life gamblers. If you view your stock investments as investments into a company, one that will have to supply your family for the next 20 years, then do some research on the company and industry and go for it. I’ve lost a little money, yes, but I’ve made far more than any index fund has ever produced.

  7. 7
    Jon Says:

    A few differences. In a casino, the house is against you. In the stock market, no one is seeking for you to invest in order to gain from your loss. Also, in a casino there are better investments than others (blackjack vs. slots). Same way in the market. Wise investors can “place bets” and beat the market, but this does require skill and discipline. All things considered, I’m not going to gamble in a casino, however my stock portfolio tends to leans towards higher risk/higher yield.

  8. 8
    razmaspaz Says:

    “For every dollar won over the market, one must be lost”

    I would love for someone to elaborate on this. Seems to me that it really isn’t true, but I can’t put a finger on why. The market overall only goes up because the overall demand for the finite number of shares in the market increases. it goes down due to the converse. Dividends and new investors are the only things that can increase the demand. Is there another force creating demand that I’m unaware of?

    Until everyone sells its all just paper wealth, and if everyone sold it would be worth nothing. I’m not sure I’m making sense on this, but I’m not sure that statement makes sense either.

  9. 9
    Dylan Says:

    @ razmapaz – More money cannot be won through trading than lost. That money has to come from somewhere. People usually get tripped up on this because stocks also tend to appreciate which creates wealth, in other words, the value of the underlying companies increase.

    Here is an example, let’s say you and I each own an equal amount of every company in the US stock market proportionate to its size. Then I sell you a chunk of my GE stock, and I use the proceeds to buy a chunk of your ExxonMobile. That will either prove to be a good move or a bad move. Let’s say it turns out to be good for you, and at some future point you made $1,000 more than if you didn’t make those trades. Well, that means I lost $1,000 at that same point. It doesn’t matter how much the stock value changes by, and our single transactions did not change the value of the stock. (This example ignores other costs associated with a trade).

  10. 10
    razmaspaz Says:

    @Dylan
    But thats not the whole picture. People enter and exit the market all the time. The influx and outflux of money is what causes rises and dips in the market. It is entirely possible for a new investor to increase the money pool (while the number of shares of “the market stays constant) and in turn raise the price of a share of the market. If I exit at that time I make money, and the other investor may or may not lose money.

  11. 11
    Dylan Says:

    @ razmaspaz – The rises and dips are caused by more buyers or sellers at a given price. A trade has a buyer and a seller and a price (it actually has two prices, the difference of which represents the financial intermediaries take, which results in the negative-sum). This is how the value is established, and anyone that holds stock will participate in value changes and those in cash will not.

    I’m not disagreeing that that the market changes in size. I’m simply pointing out the zero-sum math involved. Trades just establish value at points in time.

    For you get out of the market, someone still needs to buy your shares. The other side of that trade cancels you out. If I buy all of your shares and the market goes up $1,000, I gained $1,000 as a result of trade and you lost $1,000 verses not not having made the trade at all. In other words, good decision for me by $1,000 and bad decision for you by $1,000.

    This zero-sum result is not a theory, it is how the markets work. Trading does not create value. It is the exchange of like value.

  12. 12
    razmaspaz Says:

    It makes sense that someone wins and loses on every trade. that part I can see.

    “The rises and dips are caused by more buyers or sellers at a given price.” Still doesn’t make sense. Lets look at the market as a whole, and pretend that you can buy a share of “the market”. that share’s value is determined by the number of buyers vs sellers. If there aren’t enough sellers the price goes up until there are enough sellers.
    If you are looking at the market as a whole the only way you can have more buyers is to bring money from the “sidelines”. The only way to create new sellers is to move money to the sidelines. This is the case because there is only 1 product in the market (total market shares). So my point was that dips (more sellers) are created by people leaving the market, and rises (more buyers) are created by people entering the market.
    if thats true than every point the market has ever gained has been from people entering into it.
    You’ve answered my original question to satisfaction, but something still feels incomplete about the whole thing. Don’t take this next statement as an aversion to risk, because I have a generous portion of my net worth invested in the market, but I can’t help but feel that there is a house of cards being stacked up in the market and that on some time horizon (probably 500 years or so) it will fall down. I mostly feel this way I think because sellers need buyers, and what happens if nobody is buying?

    At this point I get the basics of market mechanics, and I think that I’m sitting at a plateau not getting a few things that if I could just get over them I would actually really understand it (not that this knowledge will translate to increased returns)

  13. 13
    Dylan Says:

    Razmaspaz, there are never more buyers than sellers or more sellers than buyers in existence, only at a given price. there are always enough buyers and sellers because the market changes its price ensuring this. An increase or decrease in value is the result of sellers and buyers agreeing on a price.

    As far as new money entering the market, as long as there is a market for companies to raise new capital through public offerings (and there should be as long as capitalism continues to thrive), new companies can continue to come to market and existing ones can expand.

    Knowledge about the market may increase your returns if you lack of knowledge is keeping you from getting your fair share. Judging from some of the other comments, not everyone will agree with this and that’s OK, but the sooner you understand how markets work, the sooner you will understand that you can’t beat the market by design. Just like you cannot go to a casino and beat the house by design.

  14. 14
    razmaspaz Says:

    @Dylan – We may be arguing syntax here, but I want to make sure.

    “there are always enough buyers and sellers because the market changes its price ensuring this”. Right, but the market changed its price as a reaction to a new buyer or seller. The new buyer or seller causes the market to adjust until the equilibrium is restored. This is not instantaneous, and for those moments there can be wild fluctuations while a seller looks for a buyer or vice versa.

    “as long as there is a market for companies to raise new capital through public offerings” That isn’t necessarily new money entering the market. It could very well be that a new IPO only increases the number of shares on the market and dilutes the value of the existing shares in the process. An IPO still has to attract new money to the market before it can increase the value of the market.

    BTW, I am learning here, so thanks.

  15. 15
    Dylan Says:

    @ razmaspaz – I’m not sure if we’re talking about the same thing or not, so I try to clarify. The buyers and sellers already exist, they just have to agree on a price. When you see a real-time stock quote, that was the last trade. If buyers and sellers collectively agree that it was a fair price they continue to use it, if not they trade at a higher or lower price. When a “new” buyer emerges into that environment, that buyer doesn’t necessarily move the market unless they (1) want to buy more shares then are being offered at given price and (2) are willing to pay a higher price for those shares.

    I’m not sure I follow your second point. An IPO is an initial public offering, the shares are created by the company and sold to raise capital. No dilution occurs here. If there is not a market for purchasing an IPO, no one will bring it to market.

  16. 16
    razmaspaz Says:

    @Dylan –
    On the first point we are talking about the same thing. Every new buyer or seller moves the market, it just might not be by a whole penny.

    As for the second point, at some juncture I thought the conversation turned to the whole market. When I say an IPO dilutes the market I mean this: If there is $100B invested in the market and an IPO (for a new company) is offered for $10M, that IPO must bring new investment into the market in the form of new investors (to the tune of $10M), or it just dilutes the value of every other company in the market. This has to be the case because those who want to buy shares in the IPO must sell $10M worth of another company in order to buy the new one. Zero sum, like you said earlier. My point is that an IPO doesn’t increase the pool of money in the market, only NEW investors can do that.

    So I guess my whole house of cards concern comes from the worry that at some point it becomes more difficult to attract new investors, and growth comes to a halt. This is what happened in 29 (isn’t it? – when shoe shine boys were giving stock tips there was nobody left to invest), and in theory it is what is happening now (take Jim Cramer’s Popularity as proof) as we lose investors during a credit crisis.

  17. 17
    Dylan Says:

    Razmaspaz, I thinks some of the confusion is in using new “investor” and new “money” interchangeably when they are not the same thing.

    Saying, “Every new buyer or seller moves the market,” in not correct.

    The zero-sum result is verses the market.

    People bring new money to the market all the time (Investing a portion of wages, reinvesting dividends, selling private holdings, etc.).

    I’ve tried to address most of your questions. I suggest taking them to an online forum where your questions can get more visibility and perhaps someone will say something that clicks better. Keep with it, and the picture will come into focus.

  18. 18
    misanthropope Says:

    raz:

    stock sale is zero sum in exactly the same sense as any transaction in commerce: not at all.

    in the frame of reference of each party, he gains (otherwise the transaction wouldn’t take place), and the other loses equivalently. but your opinion of the other side’s “score” is perfectly meaningless! and even if there were a “first person omniscient” viewpoint (mine….) if i gain a dollar at your expense, net _utility_ of the universe has certainly increased.

    the stock market is not fundamentally a pyramid scheme as you seem to think. remember at the base of the whole edifice is the potential dividend stream generated by the companies themselves. if my right to sell the shares in my portfolio were somehow stripped from me, i wouldn’t lose a whole lot of sleep over it. there is certainly some opportunity loss in that scenario, but my shares have an intrinsic value greater than their current price.

  19. 19
    Anon Says:

    “stock sale is zero sum in exactly the same sense as any transaction in commerce: not at all”

    also don’t forget, casino’s don’t issue dividends.

  20. 20
    GreatSpotRentals Says:

    Excellent article Nickel. I would also like to add that while “the market lets you participate in its overall growth potential just by being there”, it also lets you participate in its decline by just being there…. such as right now… :)

    Comments such as “If you actually do your research and time when you go in (like now) and take your profits when you can (like prior to last summer) – you can make money very consistently in the market.” made by kc, totally miss the mark. With respect to timing, you are making the assumption that you can somehow “time” the market, that you know where the bottom is, that essentially “you know something that everyone else doesn’t”. With respect to research, again “you know something that someone else doesn’t ?”. If everyone knows that that it is a great company, the valuation of the stock is already reflected by that fact. In essence, the price is inflated relative to other similar stocks because of everyone’s great expectations, and if the company doesn’t continue to meet them, the stock suffers. Look up “msft” over the last 5yrs.

    Remember stock investing 101. The value of a stock is not based on its P/E ratio, sales, profits,blah blah, etc.. It is purely based on “It’s expected future value as perceived by its current investors”.

    The two markets are fundamentally the same, with some minor differences. The risk/reward is slightly better in the stock market. Casinos cause you to win/lose by purely physical random events, while stock markets cause you to win/lose by human random events.

  21. 21
    DavidP Says:

    Hey guys; I am admittingly a recreational gambler and enjoy a day at the casino. This is an interesting conversation so let me play devil’s advocate. Let’s say I go to the casino and put down a $1000 bet at the blackjack table. My odds of doubling my money are a little less than 50/50. If I’m lucky and know how to play the game, I walk away with $2000. Now let’s say I use the same $1000 and invest it into the stock market. My odds of increasing my investment are a little better than 50/50. After 1 year, if I’m lucky and I’m a shrewd investor, the stock appreciates a whopping 20%. I’m left with $1200 minus brokerage fees, capital gains, etc. ~$1100. Therefore, higher risk, higher potential gain (or loss). Personally, I tend to win more than I lose at the casinos and lose more than I win at the stock market. I look at my 401K for the past 10 years and the appreciation is absolutely dismal. I know that financial planners will never recommend that people throw down all their money at the casinos but in reality on a short term basis there is much higher potential for gain in gambling.

  22. 22
    nickel Says:

    “Personally, I tend to win more than I lose at the casinos…”

    It’s funny, but nearly everyone I’ve talked to (that gambles) says the same thing. It’s amazing that the casinos are still in business. ;)

  23. 23
    Tim Says:

    If the Stock market trade bell rings and no one is on the floor to hear it did it really ring?

    The stock market is a Pyramind scheme he who gets out first is paid by he who gets out last.

  24. 24
    Tim Says:

    The stock market is gambling.

    Either you bet a stock goes up or you bet it goes down.

    And if your asllep at the wheel and it goes down real fast you lose big!

    The Stock Market is for insiders and brokers everyone else is just a mark.

    The insiders take the stock of the mark.

  25. 25
    mark Says:

    “the stock market is gambling”

    Er….no.

  26. 26
    mark Says:

    Diversify you portfolio (20 or more diverse investments) and go for growth long term. How is this gambling? This was well explained above by someone earlier.

    Those just bluntly calling investments gambling don’t know what they are talking about.

  27. 27
    Jay Says:

    I are really glad that I stumbled upon this article and this chat. . . . It’s very fun, and interesting points were made. No one has posted on since last October, so it is likely no one will ever read these words, but for the sake of argument (and in light of the recent economic crisis) I will be one to disagree with Nickel’s article. It’s not that I disagree that the market isn’t like a casino. In many ways it isn’t as Nickel points out. But the tone of his article and the assertions of some of the posts seem to say that investing isn’t gambling, and that just simply isn’t true.

    I studied economics at UT (Hook ‘em) and wrote a dissertation on centralized economic planning; I’m not a moron. I should apologize for that, for what probably looks like a healthy ego, but I don’t care about degrees; I don’t work in finance. I’m no one special, just not a moron.

    Mark says above: “Those just bluntly calling investments gambling don’t know what they are talking about.”

    Well, I am one of the few people with an expertise in capitalist socio-economic theory who would disagree with the assertion that market capitalism isn’t gambling, so I might as well tell you why I think so. This isn’t a popular view, but in every sense is the very essence of the free market a gamble. Now, playing the market IS nothing like playing on a roulette wheel. The game of roulette — when it is played with either just the zero or zero and double zero on the wheel — is heavily edged in favor of the house. In other words, over the long pull the casino WILL win no matter what, as long as they pulled in customers.

    The same is true for the game of blackjack. The house has a small edge, and even playing basic strategy to perfection would be a losing strategy for any gambler. But here is the catch. Ed Thorpe who discovered the mathematics of blackjack developed what is probably the first card counting systems. By using these legal systems, Thorpe found a way to reverse the edge. Now the counter had the edge, and over the long pull would win. He might not win at any given session at the table, but over time he was assured victory. Casinos, not the law, prevent counters from playing at the table.

    So here’s the point. In the game of blackjack there are 52 variables. Probabilities of those combinations of those variables are calculable to any decimal point you desire — PERFECT strategy blackjack computers have been around since the 70s, when they were legal, and now I think the iPhone has a widget that plays perfect blackjack: it keeps a running count, and calculates the odds against the player’s cards beating the house’s!
    With just the simple skills of exploiting knowledge of two variables — high and low — a player can become a blackjack professional, a player with an undeniably, mathematically sound strategy. IS THIS GAMBLING? Yes, because any given hand could win or lose — what is required is a large set, a sufficient sample to show why his bank roll keeps getting fatter. But the fact also exists that there must be a few statistical aberrations, some poor bastards who despite the strategy are just losing players. What are the odds of being such a loser? They are small when playing perfect strategy — so it is still a gamble.

    NOW . . . anyone who tells me that when they “do their homework” about a company, or a particular stock that they are not gambling, is missing something. For that decision to bear positive fruit would require an unbelievable number of things to fall into place. There are more variables than can be counted, or calculated. In a single deck black-jack game there are always 52 variables. In global economics there are more factors than can be imagined.

  28. 28
    Steve Says:

    It seems those of you who interpret the market as a form of gambling seem to ignore the broad-ranged implications of risk-tolerance levels.

    Any form of risk could be considered gambling, for by its very definition it is considered to be an investment with a certain level of potential for financial gain. (Obviously a person does not make an investment to intentionally lose money.)

    A person who invests money in treasury bonds (a risk-aversive move) is still assuming a slight degree of risk provided the government always has the ability to bankrupt itselt. Because of this risk, it is still inherently a gamble.

    Let’s clarify our definition of gambling into it’s varying degrees of risk instead describing the rainbow as merely visible light.

  29. 29
    Kingsley Says:

    Investing in Stock market is not gambling…….But if you need to play gambling in the stock marke you can still do so….
    Since gamblin can take place where ever you see the uncertainty…

    You can play soccer…for healthy and wealthy…at the same time one can play gambling while you are playing…..Do we say playing soccer is gambling?

    When gambling is concerned….for some one to win another has to lose….which is a must….But when you invest in the stock market when you win……so win the others…when you lose ..so lose the other….

    in the ultmate analysis investing in the stock market…gambling or inveting is an attitude of mine…

  30. 30
    John Says:

    Charlie Munger always compares betting on stocks to betting on horses. You are not all smarter than Charlie Munger and therefore, yes it is like betting but with BETTER ODDS.

  31. 31
    Kunal Says:

    In investing, the odds are in your favor.

    In gambling, the odds are against you.

  32. 32
    sam Says:

    “in investing, the odds are in your favor”

    has the GFC taught you nothing? diversification has not saved you from a loss.

    comparing the stock market to roulette is too much of a stretch. I think its more like poker.

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