Investing or gambling?

How do we distinguish between gambling and investing? It is surely a simple question. Yet the answer is not so straightforward. There are also numerous traps – you must make sure you aren’t in one already, and if you are, you must deal with it head on – and that requires uncomfortable honesty.

 

 

Much of what happens in our lives is a combination of skill and luck, albeit a different balance depending on the precise circumstances.

 

For example, team sports are fun (and less predictable) because the most skilful team doesn’t always win. There is a lot of randomness occurring within the game – luck plays a significant role.

 

At the other end of the scale, when you go and see a dentist, skill is a more over-whelming factor. You are unlikely to lose all of your teeth randomly and unexpectedly.

 

On every occasion before I go to the dentist, I can make a confident prediction about the outcome.

 

On every occasion before I go to a football match, I cannot make such a confident prediction

– which is why the bookies make so much money. 

 

Somewhere in-between are financial markets, and your interaction with them. 

 

There are a vast and complex web of matters which impact financial markets, and whether and to what extent you or I might be impacted by them is largely a matter of luck.

 

But what isn’t a matter of luck is how we, as investors, deal with random, unpredictable, events – more importantly, how we plan to deal with them.

 

That plan will be all the better if you have a decent understanding of how markets work, in particular bubbles at the moment, and the role of your personality and behaviour - yes, you. Of course being a bit introspective is uncomfortable – but this is what will drive your success, or lack of it.

 

 

By the 19^th century it was well understood that investment bubbles arise when some new technology captures the imagination of the general public AND this is combined with easy money e.g. as today, with easy access to debt and the lowest interest rates in 300 years. (P.S. I prefer the term mania at this stage of the cycle, as we observe an extreme psychological phenomenon, a mania, rather than just extreme valuations, bubbly valuations. But I use them here interchangeably).

 

Someone who observed the economic potential of canals in the late 18^th century or railways in the mid 19^th century were absolutely right. Yet fortunes were lost in investment bubbles derived from these innovations.

 

Similarly, fortunes were lost by investing in Microsoft in 1999 (it fell 65% from its peak), but it did not mean it was a bad company. Similarly, Apple which fell 81%, or Intel, down 82%.

 

In the same way the surge in the price of bitcoin tells you nothing about whether it is a great innovation (though the underlying technology, blockchain, is undoubtedly transformative).

 

We can all swap opinions about bitcoin, but bitcoin as an investment can realistically only be judged through the prism of the behaviour of investors. Just as with canals, and railways, and Microsoft/Apple/Intel in 1999 – there are hundreds of other examples over the last 300 years.

 

 

In the August 2019 teleconference there was analysis of not so much what makes a bubble, but rather what it looks like when it bursts. The latter is useful in two respects:

 

It scares you rigid about the downside – very valuable if you have a tendency to be both over-confident and tunnel visioned.

 

It helps you spot the potential once it has crashed.

 

This analysis was shown in the “Bubble X-Ray” blog.

 

Among other assets to illustrate the point, I showed this chart. 

 

It’s that same exponential rise, reaching up to the sky, in common with all bubbles and manias over 300 years of financial history.

 

 

This was bitcoin from 2016 to 2018. Guess what happened next…

 

 

It all came crashing down back to the beginning of the trend in the classic 3 legged move shown by the pink line.  The same as the Tech Bubble and so many other bubbles throughout history.

 

This 3-leg move down is important to watch for as it corrects the bubble. This is what I said in the Summer of 2019:

 

 

That was not a recommendation for Bitcoin, rather some basic but very effective technical analysis on an asset class which sits outside my investing universe. Since that date Bitcoin has gone from 12,000 to 56,000.

But it is not just the charts which tell you what you need to know – you can also learn a lot from listening to what others are saying and watching what they’re doing.

 

What can we learn from gambling tendencies, and why do we gamble in the first place?

 

 

 

Gambling is one of those activities where people effectively can get something for nothing, which is why some people will take risks.

 

For example, the attraction of the lottery is that, for a very small stake, you could change your life overnight.

 

Counter-intuitively, gamblers are not necessarily or primarily driven by the profit motive. Occasionally betting on your favourite team can be fun – and if you are watching the match on TV or live, it adds an element of excitement.

 

Nothing wrong with that.

 

Apparently, older people tend to choose activities that minimise the need for complex decision-making or concentration (e.g. bingo, slot machines).

 

Women tend to prefer chance-based games and men tend to prefer skill-based games.  Even in some games that are predominantly chance-based, men attempt to impose some level of skill.

 

Even men playing slot machines will kid themselves into believing it is a skill-based activity. It is the powerful illusion of control which hypnotises people into believing they have a greater chance of winning the lottery if they choose their numbers, rather than opt for the Lucky Dip, where the computer picks random numbers for you.

 

Women are more inclined to dislike being seen losing on a slot machine. In contrast, for men, it is a machismo thing: “Yes, I’ve lost £500, but I can afford it” they say, as they puff out their chest to their friends.

 

The motivations for any one person also evolve. Initially gambling might be fun or exciting, then the progression to problem gambling emerges once there is an obsession with winning money and chasing losses.

 

 

 

 

 

 

One bitcoin trading platform recently revealed that 86% of its clients fall under the age of 41.

 

This is in line with the RobinHood phenomenon that we have covered previously. The suicide of one young man was particularly tragic, and the speed with which money has been lost is now legendary. And it wasn’t just younger people. We also reported how one 60 year old lost all of his retirement fund in a few days.

 

All of this is classic mania behaviour. 

 

Similarly a few weeks ago I revealed that:

 

 

And the guy who said that of bitcoin is very clever. But a big brain is no barrier to stupidity when it comes to investing. We have regularly shown this graphic. One of the most brilliant people this country has ever produced – he lost everything. He had one giant Achilles heel – lack of personal insight.

 

In the book “Fifty Years in Wall Street”, written in the 19^th century, Henry Clews wisdom was that:

 

 

 

Let’s try and prove Henry wrong. And prove wrong those who say you are gambling, obsessive, and have completely closed your mind to other points of view. Let’s prove you are investing, and not gambling.

 

If you are over-committed to bitcoin right now – which means having more money invested than you can afford to lose – at the very least be prepared to hold two opposing points of view.

 

 

And then reconcile this in the only way possible. Have a stop-loss. Whether it is 10% or 20% or 30% below current prices – write down your commitment to sell bitcoin at x price, and tell your friends too – this is pre commitment. If possible, fix that stop-loss on your trading platform – in this way it will be automated, without you having to take action at the time when prices are falling.