Who is the House and who is the Gambler?

Posted by downtowntrader | 3/04/2009 10:50:00 AM | 2 comments »

I was digging through some older post's today and thought this one might be worth reposting.

Whether fairly, or unfairly, trading gets compared to gambling all the time. I think there are more similarities then most traders care to admit, as gambling has been made illegal by hypocritical governments who then sponsor lotteries, while Wall Street is revered as a place where an honest Joe can become rich by investing his hard earned money. Let's look at some similarities:

  • Both deal in probabilities and on exploiting a mathematical edge over the long term.
  • Both have periods where luck will override statistical probability.
  • Both reward a small group while exploiting the masses.
  • While odds are fixed in gambling depending on the game being played, and odds vary greatly depending on the market environment, both allow you to manage your betting to when the odds are in your favor.

I was reading through the comments on a post the other day and I found it interesting how reader compared the markets to the "house" and that the more hands you played, the more you would tilt the odds towards the house. I have a different view on who the house is in trading.

I think too many traders think of themselves as trading against the "markets". In reality, for every trade you make, there is another person betting that you are wrong. The exchanges are there to facilitate the trade, you are not trading against them. And although the majority of volume comes from institutions, there are still market makers and specialists who are human that manage each specific trade. So who is the house? In Gambling, the house is the Casino who is exploiting a statistical edge in order to make money in the long run. In trading, the house is the trader who is trading a system with a proven positive expectancy. In both, the house understands that they will experience times of loss, but that in the long run the odds will be in their favor. There are many different "houses" in trading, but you can guarantee that they have the odds in their favor.

So who is the gambler? The gambler is the person who bets without an edge, plain and simple. The gambler will win on enough trades to keep them coming back, but in the long run, the gambler will part with his money whether it's at a Casino or on E-Trade.

Another point was discussed limiting trading frequency. It is an interesting subject because there is a fine line between exploiting your edge, and over trading. In theory, when there is a statistical edge, it should be used as often as possible in order to have the luck factor neutralized. However, in trading, one has to be careful that taking too many setups results in taking mediocre or substandard trades, thereby reducing the expectancy of your system. However, if a system is traded faithfully there really shouldn't be any reason to limit the trades taken unless there are money management reasons for it.

Next time you take a trade, think about who would be on the other side of the trade and why they think you are wrong.

Who is the house and who is the gambler?


  1. justin.harper // 3:11 PM  

    “In reality, for every trade you make, there is another person betting that you are wrong.”

    Wrong wrong wrong. This is a common misconception. Only derivatives trading, where there is always a counterparty, is zero-sum. Trading of equities is most definitely NOT a zero-sum game.

    Imagine stock "A" lists at $1. Adam buys the stock from the company for $1. Adam sells to Bob for $2. Bob sells to Charlie for $3. Charlie holds the stock into perpetuity.

    Who lost money? Nobody. Equities trading is only a zero-sum game when opportunity cost is considered.

  2. downtowntrader // 3:33 PM  

    Opportunity costs is a huge part of this thought process. If Bob made the $1, it's a $1 that Adam didn't make. The key point I am trying to drive home is that there isn't a single entity named "the market" acting as the house. It is comprised of millions of other market participants, large and small, each trying to make money at the expense of another. A trader needs to develop their edge, so that they become the house in effect.

    Thanks for the response,