Investing is Not the Kind of Gambling You Think!

Yes, a face can launch a ship, but it’s words that cause wars.

Example 1: Nature means two mutually exclusive things

A conflict between PETA and Park Service rangers can be traced back to a 19th century British philosopher, John Stuart Mill. Mill wrote a book called On Nature. In it Mill noted that we use the word “Nature” to mean two mutually exclusive things: (1) everything except “man” and (2) everything including man (i.e., we too have a human “nature” so we’re a part of Nature).

The confusion begins, said Mill, when people using the word switch back and forth between meanings of the word “Nature.” The conflict starts when people use the same word, “Nature,” to mean two mutually exclusive things.

PETA clearly believes that nature means definition (1). Nature to PETA is exclusive of man. PETA feels we should all butt out and let nature alone.

The U.S. Park Service believes in definition (2) – that man is part of Nature. However, taking the biblical saying that God gave “man” dominion over the earth and all of its creatures, the Park Service sees its role as being responsible for balancing the needs of other living creatures so that species extinction doesn’t happen to any of them.

Thus, a few years ago the California Park Service and PETA came into conflict over those principles in the San Francisco Bay Area. A predator was wiping out a bird species. The Park Service stepped in to protect the bird; PETA stepped in to protect the predator, arguing that humans should leave “Nature” to run its course.

No doubt you’re thinking “OK, Nancy, interesting story, but what on earth does this have to do with investing as gambling?”

Example 2: Gambling means two mutually exclusive things

Gambling is a similar type of word. It means two mutually exclusive things. There are two types of gambling: (1) gambling games based on the “law of probability”, and (2) gambling based on human intelligence (i.e., pari-mutuel betting).

The confusion between these two meanings is similar to that of the debate about Nature. Definition (1) of gambling, i.e., the law of probability, excludes “man”. It doesn’t matter whether a person picks out the marked balls that lead to a cry of “bingo” or if a machine mixes up marked balls and spits them out for the weekly state lottery. In both cases the law of probability rules. The law of probability applies to all of the things that people gamble with: marked balls, dice, coins, cards, etc.

Definition (2) of gambling includes human beings; in fact it is based on the existence of human beings. Pari-mutuel betting is a form of gambling where human beings pit one opinion against another in advance of the outcome of some kind of event. Usually these events are based on the activities of living beings: athletes, bulls, gamecocks, greyhounds, horses, etc. Those who make the best “guess” based on what they know about the kind of race or contest being bet on are the winners.

It’s vital that we all understand how these two types of gambling differ.

The importance of understanding that investing is pari-mutuel gambling

Investing is an example of pari-mutuel betting. There used to be things called stock certificates that one kept in safety deposit boxes, but no more. Now, you only know the value of your investment when you gain or lose money at the moment of selling your stock or your stock mutual fund in the market. No object is involved in the “sport” of investing.

Instead, the underlying event that investors in a stock are betting on are the human activities of those who control, manage and work at a a corporation, as well as the human activities of those outside that corporation that somehow impact that corporation during the period of the “race,” i.e., the period of the individual’s ownership of that stock.

Investing is not similar to games of chance where events are random and governed by the law of probability. The law of probability says that repeated testing shows that the things involved in games of chance have a certain percentage, or “chance” to occur each time the object is used e.g., there’s a 50/50 percent (or chance) for heads or tails on a flipped coin regardless of who or what flips the coin.

For any particular flip of a coin, toss of the dice, or roll of the wheel, lady luck rules. And for sure, past performance is absolutely no predictor of future performance.

This isn’t the case with investing. In investing, past performance can indeed be a predictor of future performance, but often it isn’t. That’s not due to the law of probability though; it’s due to human fallibility. Much like weather forecasting, investor forecasting takes account of complex factors, not all of which can ever be known at the time.

Investing is similar to games where human sweat and ingenuity play a big part in the chance of either team to win, and in the chance that someone gambling on those games will win or lose. Those who know the game well will have better odds of making the right bets and winning.

Sure, luck might cause you to lose occasionally when betting on pari-mutual events. After all, who can predict a horse that trips or a “flash crash”? But to win repeatedly in the contest of investing, you need to be more knowledgeable than your opponents, not just luckier.

Copyright © 2010 Nancy K. Humphreys