Trading stocks is associated with investing. “I buy stocks. I invest.” At some point buying and selling stocks as a day trader leaves the realm of investing and becomes gambling. When does that happen?
The Miriam Webster Dictionary defines “Invest” as “To commit money in order to return a financial return.” They define “Gambling” as “the practice or activity of betting.” These sound similar. If your client is a day trader, they might liken what they do to a “trader” at a Wall Street bank. The definition of “trader” is “a person who buys and sells goods, currency or stocks.”
These terms are starting to sound very similar. Let’s apply common sense.
- Is the return expected immediately? When most people invest in stocks, they expect the stock to gradually appreciate over time. Total return stocks also pay a dividend while you are waiting. When you visit a casino and play slots, blackjack or roulette you get your result immediately. If the strategy involves buying and holding, it’s usually investing. If you expect your return immediately, often before settlement day, it’s gambling.
- Do you understand what you are doing? Investing works on fundamentals. Technical factors too. Some strategies, like trading on margin or buying options are ver complicated. If you commit money understanding the risks, you are investing. If you committed money without knowing how the outcome is achieved, you are gambling.
- Is there a fundamental story why this stock should rise? Investors traditionally buy stocks based on earnings. The stock will rise because the actions the company is taking will increase sales, profits and earnings. Investors understand the rationale why a stock should work out. If you buy without having a logical reason why the stock should appreciate, that’s gambling.
- Are you spending money you cannot afford to lose? Investors understand risk and choose their investments accordingly. Investors commit money, often according to the Investment Pyramid. The majority of the money is safe money. People who lose their gas money and toll money at the casino are gambling.
- Are you acting on hunches or research? Investors often research fundamentals, seeing hidden values others have missed. The anticipate trends. Investors have a rationale why an idea should work out. Gamblers hope they get lucky.
- Do you have the risk of losing your entire investment? Investors rarely put themselves in an all or nothing position. They set downside limits and stick to them. Investors diversify and try to limit losses. When you play roulette, blackjack or slots, if you lose you walk away with nothing from that hand or spin.
- Do you go “all in?” Do you commit all your money on one idea? Investors spread their risk. Gamblers will risk it all for the big score.
Clients who enjoy day trading might think they are investing. When emotions take over and caution goes out the window, they are gambling.
Related: Why Isn’t Everyone Rich?