Many people have the impression that trading is like gambling. Obviously, non-traders have no way of knowing how much dedication goes into a proper risk and reward evaluation of stock picks. On the other hand, traders themselves are well aware that, unlike gambling, they should never be in a trade unless they have a clear and obvious edge (at least, obvious to them.)
It’s well known that in almost every case in gambling, the house has the edge. In those few cases in which it doesn’t, the edge the gambler might have is slight at best, and is usually strongly discouraged by the casino. I have heard of a few successful professional gamblers, but they treat gambling just like a business and have incredible discipline.
Let’s dig a little deeper and see what it is that gives a trader an edge over the “house.” Although a good trader and a good gambler both have systems, a trader’s system is usually much more robust and puts the odds more clearly in his favor than a gambler’s system. Traders also have more clearly defined risk management because any trader with experience knows that a stop loss is essential for improving the balance in his or her trading account. Also, a good trader usually evaluates the worst case scenario and the worst case risk in a situation before deciding to take the trade.
In fact, good traders always make sure they understand the worst case scenario before considering a trade. It’s not the winners who destroy your account. Instead, it’s the unexpected (and often) large losses that do!
Most gamblers seem to be far more focused on the reward and totally ignore the risk that they might go bust. A good trader is ever vigilant about the fact that it’s far easier to lose money than to make money. He leaves nothing to chance, thereby minimizing his losses.
Traders can develop an edge through their system by having, for example, better screening techniques than most market participants. They can also develop this edge by having carefully studied and refined techniques for entering and exiting trades. Of course, as previously mentioned, traders pay specific attention to managing losses.
So are you a trader or gambler? It really depends on how clearly defined a system you have and how disciplined you are about adhering to that system. So the next time you’re tempted to deviate from your written trading plan just remember this: once you do that, you stop being a trader, and you’re just another gambler.
Doug Newberry, of Investing Systems Inc., is one of the Directors of this software company which develops and markets software and systems for every kind of trader and long-term investor. You can learn more about the difference between Trading and Gambling at Stock Picks [http://www.stock-picker-rt.com].
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