Is there a difference between gambling and trading the markets?
In this episode, Walter and Darren take an extended look into the parallels between trading and gambling. Why should traders understand gambling? Darren discusses an article he came across and how this opened up a different perspective for his trading.
Walter talks about a popular boxing match and how this can help you answer the important trading vs. gambling question. All of this and more in this episode of the 2 Traders podcast…
Download (Duration: 22:36 / 25.8 MB)
In this episode:
00:32 – lost voice
02:00 – betting on horses
04:45 – longest losing run
07:50 – grind this out
10:10 – sharps
12:46 – bet on favorite
14:44 – pile of gold
16:37 – falling knife
18:55 – obvious parallel
20:20 – playing field
22:03 – horse gambling
Darren: But why is that the case? Why isn’t the high win rate the way to go? Why when you go to bet the horses, do you just snap back on a favorite?
Announcer: Two Traders, Darren and Walter, pull back the curtain on profitable trading systems, consistent money management, and profitable psychological triggers. Welcome to the Two Traders Podcast.
Walter: Welcome to the Two Traders podcast. It’s Walter here. Hi, Darren. How are you going today?
Darren: I’m very good, Walter.
Walter: I’ve kind of lost my voice but it doesn’t matter. We push on because we’ve got a really good topic today. I saw you posted in the forum at Naked Forex Now, you posted this really interesting article that I’ve been reading for the last 20 minutes or so and it really has brought up a lot of things that I think are quite interesting for traders.
I mean, putting aside the reaction that traders have when people start drawing parallels between trading and gambling, I think there are some really interesting parallels and I’d like to hear your thoughts on this. Why did you want to bring attention to this, I suppose? And I know you did it in a cheeky way but why were you doing that?
Darren: The reason I wanted to do it was because I think the parallels with gambling and trading, if you understand that, I think that understanding can be one of the… Especially if you’re a beginning trader, if you grasp that understanding then I think that can be one of the one thing that’s really going to make a difference with your trading results.
The article I posted was a professional horse racer. A horse race — better gambler is what you’re gonna call them– who is talking about essentially the money management rules to gambling, basically, to betting on the horses and the important things to consider.
Essentially, what he is outlining is the elements that go into a risk of ruin calculation. He’s talking about the risk/reward, how much of your account you’re betting on each race, your strike rate which is your win rate essentially, and he’s also talking about this idea that the notion that you just need to pick a winning horse is wrong. You need to look at all of those elements. The strike rate, the odds, and the profits, the returns. You have to look at all of those together to make any strategy work.
I just thought it’s really interesting. I think the problem is when you dismiss this link between horse racing — and not just horse racing, gambling and trading — you’re in danger of going down the route where you think that trading is, somehow, the outcome is more determined.
You can determine the outcome more in trading than you can in gambling. Essentially, they’re both. The outcomes are really uncertain and without this sort of “money management” ideas behind both, then you’re going to struggle to make money.
Walter: Yeah, absolutely, and you get paid as a trader. As a speculator, you get paid to take on risk. I mean, that’s essentially why we’re being paid to do.
Darren: Yeah, and I think a lot of people don’t see that way. I think they see it as an exercise of skill where your goal is to completely remove risk. I think that’s kind of a mindset that people take to trading.
And you know in the article, he talks about people gambling on the horses, betting on horses, having the same issues psychologically and emotionally that we all suffer from in trading and he explains that if you understand how this combination of figures works together then you better assume to make money in the long run.
Walter: Yeah, we’ll post up this article. It’s a great article. We’ll post this up in the shownotes for the episode. For me, what I like about this — well, I actually have a… I end up always somehow talking about this but I actually have a calculator on our website at “fxjake.comforex/risk” where anyone can get one of this calculations.
He has a calculation in his article of the actual calculation of the longest losing run and that sort of thing. There’s two ways to calculate it. Basically, you can calculate it using a formula like your post in the article or you can do that with like a Monte Carlo study which is basically just simulating a bunch of results over and over again and trying to find the average.
A lot of traders will do that Monte Carlo testing win day and look at systems because they want to figure out what’s the average. What am I to expect in terms of consecutive losers and winners and all that sort of thing because you’ll never know what kind of run you’re going to get, right?
Like, Darren, you start trading a system and you just don’t know if you’re going to get 7 losers or 7 winners out of the gate or something else in between. Obviously, your win rate place a big. It’s a big factor if you have a higher win rate, you’re going to be less likely to see a long string of losers but they will happen and vice versa with the low win rate system.
It’s really important because I don’t think enough traders consider this. They don’t consider the fact that the losing streak, which is basically a drawdown, a consecutive bunch of losing trades in a row, that’s why most traders quit.
When I say “quit”, I mean they quit their system. They quit their trading altogether that’s why they quit but yet nobody very rarely do you see traders especially like you say new traders come into the game thinking, “Okay, let me figure out what’s likely to happen here. If I had nine losing trades in a row, will I just go ahead and throw in the towel?” They don’t even consider that.
Darren: Yeah. And, I think the numbers are probably a lot a lower that as well.
Darren: I mean I’m looking at the chart now and it’s saying, “If you have an 85% strike rate, 85% win rate you’re still going to get four consecutive losers.” And I know traders with four consecutive losers, they’re in the hole, psychologically. Four consecutive losers, even a 50% win rate, 10 consecutive losers. I mean, that is every 1,000 bets but it might be the first 10 bets you take.
Walter: Yeah, exactly.
Darren: And there’s no way of escaping that.
Walter: That’s right. I mean, you can run all the Monte Carlo, you can do everything. The only way really to… I mean, really the only way to make sure that you’re able to withstand it is to bet a very small amount.
Darren: Yeah, I think so. But, does ego come in more than money? Is it just a fact that you’re losing that is more damaging than the fact that you know your money is going down?
Walter: Yeah, I think so. I think that’s why we all, as beginners, drawn into high win rate systems, isn’t it? Because we think that we’re smarter than other people. I mean, I believe that traders as a whole, oftentimes are very successful at other things.
Maybe running a business or whatever and they just think that it’s like the same things are going to translate. The same sort of, “I’m going to stick to it. I’m going to grind this out. I’m going to make this work. I’m going to really sort of impose my will on this business”, that doesn’t work in trading.
All that stuff that works, if you’re trying to build like a huge franchise business. Let’s say that you are selling burgers or something and you have all these. You’re building this franchise in your home country, all the things that would have worked in that if you try and translate and move those over to trading it just doesn’t work.
Darren: Yeah. I mean, really, not unless you’re a professional gambler. What the other fields, where you can be successful but you know you’re losing so often.
Walter: Yeah, exactly. It’s devastating.
Darren: I mean, it doesn’t work in sport, does it?
Walter: Yeah, exactly. I’m listening — I’ll put this in the shownotes too — as one of my little treats I like to listen to this podcast about American Football. The guy has — this guy that I listened to — he’s built his own little empire of podcast.
He used to have just one podcast. Now he has four, five podcasts and they are all on different elements of the sport. One of them… It’s fascinating because I used to think, you know like a lot of traders used to think gambling was so far away from trading.
Well, he’s got this podcast that I’ll link up in the shownotes where he basically talks. He’s a professional gambler. This professional gambler has won some sort of gambling-world thing you know twice in a row or whatever or something like that. Two or three times this guy has won it.
He is, essentially, he was trained as like an insurance actuary or whatever. He is essentially like a statistician and the way that they that he approaches it is fascinating because to him the most important thing is the line.
The line is which team is favored and by how much. The line will move up and down and so he’s basically playing the line. He plays the crowd and then they had another interview where they interviewed him like a bookie in Las Vegas.
Like, he was a guy who runs one of the… No, it was actually an online. I think it was an online company. They were asking him questions about… It’s so funny to have these terms like the “sharps”.
The sharps come in and those are the like professional gamblers and so they’ll say, “Yeah, there’s a lot of sharp money on this and there’s a lot of — the public is on that”. Really as a bookie, all they’re trying to do is balance it out.
In others words, they’re going to make money no matter who wins. That’s what they’re trying to do and that’s why they moved the line. As I was listening to it the other day — the big news at the time as I was listening to it and as we record this — there was a big fight.
A big boxing fight which I don’t really… I mean, I’m not really into boxing for a number of reasons but it was fascinating to hear the bookie talk about it because the bookie said, “Look, we believe that the line should be like the favorite which is Mayweather.”
Mayweather should have been a favorite of like I don’t know 10 to 1 or something over the underdog because Mayweather had 149 fights in a row and the underdog, this is his first boxing match — McGregor, right?
The problem was the public was betting so much money on McGregor that they had to move the line and they basically had to make Mayweather less of a favorite. Do you know what I mean? To try and attract more Mayweather.
It was fascinating and they were talking about how, on this podcast, they’ll talk about how. What will happen is the sharps — or the professional gamblers as they call them — they’ll wait for the public to come in and make all their stupid bets, right? And then, once the public does that and the line moves in a favorable direction then they’ll jump in with their money.
A lot of times, what they’ll do is they’ll wait until the very last minute before an American Football game to bet. The sharps world because they’re waiting for the public to kind of push it with a whack so the bookies know what the pro gamblers are doing and they know what the amateur gamblers are doing. That’s very obvious to them which I find very fascinating too.
Darren: Yeah. Talking about, we obviously favor the high win rates because there’s a smaller losing streak. Okay, you lose less. Isn’t that obviously the thing that we should do? I mean, what I’m trying to do is I’m just trying to argue the case here. Okay.
We are drawn to high win rate systems because they have a lot shorter losing runs so that is obviously going to be this easiest way to make money. Now, I know we don’t agree with that statement but why is that the case?
Why isn’t the high win rate the way to go? Why when you go to bet the horses do you just snap back on the favor?
Walter: Yeah. To me that’s the same reason why when I look at the open position data with the amateur traders which are the retail traders and I see that they’re all in one trade like, 82% of them are in one trade. To me, that’s an obvious example of the Canarian occult mind of the amateur crowd doing the wrong thing so I want to be in that other group.
It’s the same thing with the favorite horse. If you would just go and bet on the favorite, for one, you’re not going to make much money. You’re going to have to put up a whole lot of money just to make a little bit back, right? That’s the definition of the favorite.
That’s exactly why — and I think this is where we’re getting at — it’s so hard to make it as a high win rate scalper essentially because if you mess up just a little bit, that takes a huge chunk out of your profits because you’re only making little tiny profits.
You’re picking up this little tiny ten-cent coins along the way and then once in awhile you get whacked with the two dollar bill, right? That’s why I think like looking back the best scalpers I’ve ever seen are very regimented. They’re like came from a military background. The kind of trader that sets a stopwatch on their desks and says, “I’m going to trade for two hours and 2 hours only.” Like, those sort of thing you know.
Darren: Yeah. When you’re talking about going against the crowd, do you like this idea of going against the crowd is that because you’re going to be right more often? Or, is it because you know when you are right, then the payoff is massive? What is the edge that is showing itself there?
Walter: First of all, like if I said to you, “There is this bird and you everytime you see that bird, if you’ll just follow that bird, he’s going to lead you to a pile of gold more often than not.” If you follow him ten times, one time everyday for the next ten days 7, 8 days of those days, he’s going to show you where these big piles of gold is. He’s going to take you to the treasure.
Well, that’s the same thing that the way that I look at the retail forex trader crowd. We know that when they all pile in and they all get in. I mean, it’s just like if we look at, historically. We look at bubbles, right? It’s like a bubble. That’s how I see this little… It has to get extreme.
To be honest with you, the fact that the markets have been so extreme for so long because usually, it just touches. What I consider extreme is like 70, 75% of the retail traders are all in one side.
They’re all like selling the USD/JPY or they’re buying EUR/USD or whatever, right? When we see those, if you go back historically, you’ll see like on the Oanda data — and I’ll link them up in the show notes for you — that doesn’t really happen that often.
It might happen a few times a year but as we record this, for the last two months basically, it’s been almost constant where we see that the markets have been completely tilted on one side for almost everyday for like the last 60 days. It’s incredible.
And so, what that is the reason why I pay attention to that? Is that’s a trend because of all the traders that I’ve… When I asked them questions — I run them through a survey, a questionnaire and I try to find out what kind of trading do they like to do — almost all of them, about 78% of them, come out as reversal traders.
They like to catch a falling knife. They like to find reversals and very few of them, about 20% of them or so, are the ones that say, “Yeah, I like to trade the trend.” If we know these traders’ loses, that they lose money and we know that they like to catch a falling knife and there was fine turning points then, if see them all in on one side, what they’re doing is they’re trying to pick the end of a trend and all of their stops are just out of reach.
If the market is able to move there and touch it, they’re going to get stopped out because they’re all trying to find out that turning point. Now, I’m not saying that the retail traders — which make up a drop in the ocean of the overall currency market — I’m not saying that they’re moving the market. All I’m saying is that they are a great sign. A great sign.
Like, if I look out the window and I see the wind in a certain direction, I can tell if when I should go to the beach, if the waves might be good today, or they might be completely ruined by the wind. All I have to do is look out on my window and I see which way the wind is going.
Well, it’s the same thing with these traders, that’s all I’m saying. I know I keep going on about this and simply because recently I’ve never seen anything like it. Where it’s been so much in one direction for so long usually like I said it’s just a very… It’s like a fleeting moment.
When you’ll see it touch 80% of the retail traders all in on one side but it’s been like these for months, it’s crazy. I think it’s a great barometer of a strong trend basically and that’s why I think it’s important. I don’t think that they’re actually moving the market and I just think that we know that these guys are amateurs. You know what I mean?
Just like this is exactly what the bookies do and that’s why I find your interest in this article so interesting to me because I’ve been listening to this gambling podcast. The bookie talking about how they know that the sharps… Like, for the recent McGregor and Mayweather boxing match, all the sharps were piling in on the Mayweather bet which is the favorite and the public was just piling in on the side of McGregor. They couldn’t believe how much money was piling in on the underdog.
It was just incredible when they have to keep hammering down the odds to try and make the favorite more desirable to balance the books out. To me, it’s very, very similar to what you see when you see all these retail traders trying to catch the turnaround point for the EUR/USD. The EUR/USD is just massive bullish uptrend and everyone is thinking it’s time to sell. It’s just, to me, it’s like an obvious parallel.
Darren: Yeah. Can you think of any reason why trading and gambling are different? Are there any sort of distinct differences between trading and gambling?
Walter: Well, one thing about gambling is I think it’s a little bit easier to fix. If I really wanted to affect a US college basketball game and bet on that game, it probably wouldn’t be that difficult.
If I have made the right friends and things like that, you could probably get to the point where you could affect a game. Well, I’m sure that sort of thing goes on and I’m sure a lot of people, for example, made a lot of money when the Swiss National Bank came out with their surprise announcement on January 15, 2015. Those sorts of things happen.
I think that the markets are much more difficult to manipulate although we’ve seen the same sort of thing with terrorists trying to do that. In other words, I think information in the markets, that affects the markets is more of a level playing fields. Whereas, I’m thinking with gambling…
In sports, gambling in particular, I think there are some people that they’re in a better position who know what’s going on and they are more likely be able to take advantage of that.
Whereas, I think in the markets, I think it’s more of a level playing field. That’s what I believe because I think… Like for example, if you work for the Australian Bureau of Statistics and you know what some sort of economic report it’s going to be the day before it comes out, they’ll keep really close watch on you and the people that — your relatives — and things like that.
They’ll know if you’re doing something beforehand to try and make money on the fact that you know that tomorrow’s job’s support or whatever is going to be poor for Australia. That kind of thing that’s really closely watched. Whereas, I don’t know…
Like, let’s say, I’m a basketball player on a team at some college in the United States and I know that our star player isn’t going to play in but the coach keeps talking like he is, that could affect the odds if that information was out there.
I think those kinds of things are more likely to be used advantageously in gambling and I don’t think that’s the case in the markets. I don’t see that to the same extent.
Darren: How do we explain the fact that a lot of traders seemed to be really against the idea of people making comparisons between …
Walter: That’s all the time we have for Part One but in Part Two, you’re going to hear Darren and I talk about parallel between gambling and trading. What the sucker’s bet is, how professional gamblers play the crowd and what did this has to do with your own trading in the market, particularly with the forex market.
Also, why some cultures look at trading in a completely different light. And finally, you’ll hear about Darren and how he looks at horse gambling and sports gambling versus trading. How it is a completely different view for him now, well in fact, in society at large.
All of these and more in Part Two of our conversation. We’ll see you next time. Happy trading!