Are you investing or gambling?

Gambling is defined as staking something on a contingency. However, when trading is considered, gambling takes on a much more complex dynamic than the definition presents. Many traders are gambling without even knowing it — trading in a way, or for a reason that is completely dichotomous with success in the markets.

In this article, we will look at the hidden ways in which gambling creeps into trading practices, as well as the stimulus that may drive an individual to trade (and possibly gamble) in the first place.

It is quite likely that anyone who believes they don't have gambling tendencies will not happily admit to having them if it turns out they are in fact acting on gambling impulses. Yet discovering the underlying motives behind our actions can help us change the way we make decisions in the future.

Before delving into gambling tendencies when actually trading, one tendency is apparent in many people before trading even takes place. This same motivator continues to impact traders as they gain experience and become regular market participants.

Some people may not even have an interest in trading or investing in the financial markets, but social pressure induces them to trade or invest anyway. This is especially common when large numbers of people are talking about investing in the markets (often during the final phase of a bull market). People feel pressured to conform with their social circle. Thus they invest so as not to disrespect or disregard others' beliefs or feel left out.

Making some trades to appease social forces is not gambling in and of itself if people actually know what they are doing. But entering into a financial transaction without a solid investment understanding is gambling. Such people lack the knowledge to exert control over the profitability of their choices.

There are many variables in the market, and misinformation among investors or traders creates a gambling scenario. Until knowledge has been developed that allows people to overcome the odds of losing, gambling is taking place with each transaction that occurs.

Once someone is involved in the financial markets, there is a learning curve, which based on the social proofing discussion above may seem like it is gambling. This may or may not be true based on the individual. How the person approaches the market will determine whether she/he becomes a successful trader or remains a perpetual gambler in the financial markets.

The following two traits (among many) are easily overlooked but contribute to gambling tendencies in traders.

Even a losing trade can stir emotions and a sense of power or satisfaction, especially when related to social proofing. If everyone in a person's social circle is losing money in the markets, losing money on a trade will allow that person to enter the conversation with their own story.

When a person trades for excitement or social proofing reasons, it is likely that they are trading in a gambling style, rather than in a methodical and tested way. Trading the markets is exciting — it links the person into a global network of traders and investors with different ideas, backgrounds and beliefs. Yet getting caught up in the "idea" of trading, the excitement, or emotional highs and lows is likely to detract from acting in a systematic and methodical way.

Trading in a methodical and systematic way is important in any odds-based scenario. Trading to win seems like the most obvious reason to trade. After all, why trade if you can't win? But there is a hidden detrimental flaw when it comes to this belief and trading.

While making money is the desired overall result, trading to win can actually drive us further away from making money. If winning is our prime motivator, the following scenario is likely to play out:

Jill buys a stock as she feels it is oversold compared to the rest of the market. The stock continues to fall, placing her in a negative position. Instead of realizing that the stock is not simply oversold and that something else must be going on, she continues to hold the position, hoping it will come back so she can win (or at least break even) on the trade. The focus on winning has forced the trader into the position where she doesn't get out of bad positions, because to do so would be to admit she lost on that trade.

Good traders take many losses – they admit they are wrong and keep the damage small. Not having to win on every trade and taking losses when conditions indicate they should is what allows them to be profitable over many trades. Holding losing positions after original entry conditions have changed or turned negative for the trade means the trader is now gambling and no longer using sound trading methods (if they ever were).

Gambling tendencies run far deeper than most people initially perceive and well beyond the standard definitions. Gambling can take the form of needing to socially prove one's self, or acting in a way to be socially accepted, which results in taking action in a field one knows little about.

Gambling in the markets is often evident in people who do it mostly for the emotional high they receive from the excitement and action of the markets. Finally, relying on emotion or a must-win attitude to create profits rather than trading in a methodical and tested system, indicates the person is gambling in the markets and unlikely to succeed over the course of many trades.