Life After Full-time Work Blog

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#133 Beware! Investing In The Stock Market Is Not A Game!

I expand on a warning given by Warren Buffett


I just noticed a report that Warren Buffett said that trading apps are a driver of the “casino aspect” of the stock market, and traders are gambling on how prices will change in the next 7 to 14 days. He warned “new entrants to the stock market to ponder just a bit before they try and do 30 or 40 trades a day in order to profit from what looks like a very easy game.”

It reminded me that, many years ago, I used a casino analogy to teach a group of pilots and their partners about investing. (The lessons are reproduced as Stages I11 and I12 on Route 2 of Freedom, Time, Happiness on my website. Read them, they’ll amuse you!)

When I first gave the talk it was obvious to the audience that my use of the casino analogy was an entertaining but not literal approach, and that the stock market is not a game. Indeed the teaching session wasn’t about the casino games themselves, but about psychology, in other words, about how to think about the games. I drove home the point that there’s no easy money to be made in an efficient market.

There’s a big difference between investing and gambling. The true investor is setting aside money with a long horizon, hoping (and yes, expecting) that the investment will grow in value because of economic growth. Gamblers have a much shorter perspective and are betting that they are smarter than other gamblers in predicting the course of short-term movements in prices. So gamblers don’t plan to hold funds or securities for long; they buy when they expect a quick upturn and sell when they expect a quick downturn.

In fact gamblers will sell in anticipation of a quick downturn even if they don’t own what they’re selling. How is that possible? Don’t they have to deliver whatever it is that they sold? Yes, but there’s a few days between selling and delivering. So they’re betting that they can sell something valued at $20 today and buy it later (in time to deliver it) when it has fallen to, let’s say, $15. (Not owning what you’ve already sold is called “being short” in the jargon.) This is actually something that investment professionals do too – though I think they’re acting as gamblers rather than investors when they do it. Hedge fund managers, in particular, sometimes bet very large amounts in this way


As I write this today, it seems that the lesson about no easy money in an efficient market is not one that the general public understands. And many think they’re investing when they’re really just betting on short-term movements. The Covid-19 pandemic seems to have generated all too many enthusiastic amateurs who dabbled with their money via those trading apps, made easy initial successes, and assumed that it was their skill that had been demonstrated to work, and that it follows that anything they do will lead to riches. Nonsense!

The fact that they had no concept of (or cared nothing about) the underlying economic value of what they were buying or selling is illustrated by a couple of examples.

The most famous one is GameStop Corp., an American video game, consumer electronics, and gaming merchandise retailer. With no fundamental change in its circumstances, its price per share varied between a high of $483.00 and a low of $3.77 in a 52-week period. There was clearly a lot of scope there to make money and to lose it! Those who bought as it rose (eventually to more than 100 times its initial sober valuation) were not buying because it had suddenly become more valuable, with greatly improved prospects of profitability. No such prospects were ever reported, or even considered. They were buying because the quick rise caused a frenzy of further buying, much of it by amateurs who wanted to buy before it stopped rising – one day its price opened at a level four times as high as it did on the previous day – hoping to be able to sell to another one of them. There’s actually a term for this behavior: it’s called “the greater fool theory,” and it says that it doesn’t matter what price you buy at, as long as you can find a greater fool who is willing to pay even more than you did.

That’s my point. Those who bought and sold weren’t offering different insights on the true value of GameStop; they were betting on the psychology of other market participants. They were gamblers, not investors.

How can this happen, in an efficient market, where there’s no easy money to be made? The answer perhaps requires a narrower re-definition of an efficient market. It has traditionally been defined as a market in which all available relevant information is known to all investors. Well, that was the case with GameStop: no new relevant information about its prospects came to light during the frenzy. What happened was that the gamblers didn’t care about its fundamental data; they cared only about what others might think as the price soared and plummeted. This was clearly an inefficiency they were betting on. Perhaps the definition of efficiency should be restricted to genuine long-term investors, with no gamblers participating. Gamblers can make otherwise efficient markets inefficient.


Another example, less familiar, is Hometown International, a New Jersey deli with a share price that makes its market value more than $100 million. Wow, it must be a chain with massive profits, based on even greater annual revenues, right? Wrong. It has one location only, and the deli’s revenues (not profits, just revenues) amounted to $35,748. Wait, there’s more! That amount represents the combined revenues over two years. So, why the amazingly high valuation? Does “the greater fool theory” occur to you? Or perhaps, as one sarcastic commentator put it: “The pastrami must be amazing.” (Actually it seems that, while the deli is the only operation owned by Hometown International, the stock is used as a vehicle for financial operations, and the corresponding financial revenues are in the millions, but I couldn’t resist the joke.)


Two more angles.

First, what about active management, by investment professionals? Surely it’s genuinely investing when they assemble diversified portfolios based on their own research into the companies involved? My opinion is: no. (I recognize that this will be seen as an extreme position.)

Whatever their passive benchmark portfolio is, that to me represents investing. Their own active portfolio represents their bets away from the passive benchmark, those bets being based on what they expect to be temporary mispricing of the securities. They’re betting that (even when the underlying market is efficient) they are smarter than the other investors whose corresponding research has got the security prices to wherever they are, and that their greater smartness will be rewarded when the prices change in the direction they expect. Their excess return, relative to the benchmark portfolio’s return, is what they have achieved.

To me, the benchmark return is the reward for investing; the excess return is the reward for betting. It’s noticeable that, in efficient markets, the long-term return from investing is positive; the long-term return from betting is typically negative.

The second angle is: am I saying that it’s a bad idea to bet on markets or funds or securities? No. It could be great fun. If you’re doing it for fun, no problem! It’s like going to a casino. Your reward, when you play the slot machines or other games, is the pleasure that comes from risking your money. Any win is a heady bonus. If and when you lose the amount you set aside for fun, you stop. No harm done, lots of pleasure and excitement, and only your “play money” is at stake, just as long as you don’t confuse gambling with investing.



I hope the takeaway is clear: there’s a difference between investing and betting, and there’s no easy money to be made in a (genuinely) efficient market.


I have written about retirement planning before and some of that material also relates to topics or issues that are being discussed here. Where relevant I draw on material from three sources: The Retirement Plan Solution (co-authored with Bob Collie and Matt Smith, published by John Wiley & Sons, Inc., 2009), my foreword to Someday Rich (by Timothy Noonan and Matt Smith, also published by Wiley, 2012), and my occasional column The Art of Investment in the FT Money supplement of The Financial Times, published in the UK. I am grateful to the other authors and to The Financial Times for permission to use the material here.

6 Responses to “#133 Beware! Investing In The Stock Market Is Not A Game!”

  1. Ted Harris says:

    Don, in my experience, I think that’s the closest you’ve come to a public rant!

    I do think that “investing” is one of the most abused words in the English language. Indeed, the majority of “investment” products are synthetics and derivatives, not participating in an entity delivering a good or service. Within two years after the debacle of 2008, Mark Mobius, and others, claimed that the markets had returned to the speculative market being close to ten times the value of the true investment market. To me, speculation – what you call gambling – should be governed by how much you can afford to lose. So I agree that a small amount of play money may be fun, but it’s not an investment.

    I might differ slightly about active management. I think that the fee one pays an active manager is to reduce volatility – particularly downside capture. However, it is imperative to understand the operational parameters contractually allowed the manager, and choose accordingly. If they introduce undue risk, they must be held to account, legally. While a young investor may be able to handle market volatility over the long haul, an older person is likely in need of a more moderate portfolio, which is entirely feasible through prudent investing.

    The “Dotcom” era and the examples you give above, are modern versions of the examples in the first hundred-or-so pages of “Extraordinary Popular Delusions and the Madness of Crowds”, a book still worth reading – at least the the first hundred pages.

    All this written as I look out my window at the tulips in our garden!

    • Don Ezra says:

      Thanks, Ted. I do recall “Extraordinary Popular Delusions” — a magnificent book, with adaptations published periodically to illustrate the current times. I hadn’t seen Mobius’s 10-times comments — it shows how much gambling dominates investment. That’s an interesting thought of yours about active management having the purpose of reducing volatility — I hadn’t thought of it as a stand-alone purpose, just a part of “make my return higher on the upside and reduce the downside.”

  2. Mike Clark says:

    Agree with the thrust of the trading argument.

    But I assert that an asset owner can take an active risk stance (e.g. low carbon) where actually specifying a benchmark to that stance is quite hard. I do not see it as gambling (simply having a risk view…). Their challenge is to specify what “success” for their supplier (investment manager) looks like and it may be a little less rigidly benchmark-specific than we have become accustomed to.

    Markets are decidedly inefficient. If all investors realised that the insurance business model begins to break down as we head north thru 3D, and we are heading to close to 4D by 2100, then carbon would be priced better, there would be more low carbon mandates and the new Exxon board would be a shoe-in!

    • Don Ezra says:

      Good point, Mike — and quite right. Some years ago Dr Geoff Warren and I co-authored an article for the Journal of Portfolio Management, in which we identified three reasons to depart from passive investing. The first is when there isn’t an index available, so active selection is your only option — a situation you identify. The second is when there’s an index, but it doesn’t tie in with your objectives — which also applies to your example, though we were thinking more in terms of fixed income indices not matching cash flow requirements. And the third is when you think you know better — which is what I see as gambling.

  3. Ted Harris says:

    Further to my earlier comments and the additional discussion, I was always uncomfortable with an investment objective of “maximizing returns”. As you and Mike have pointed out, an investment policy may incorporate some risk taking or some risk containment. There are certainly many discussions on what to expect re ESG.

    I found the term “optimizing returns” helped clients. This concept acknowledges the various components in a policy and – hopefully – leads to more rational expectations.

    All this doesn’t change the unfortunate fact that some people think they’re investing when they’re gambling.

    • Don Ezra says:

      Thanks, Ted. Yes, “maximizing” just implies “reach for the sky,” whereas “optimizing” implies “do the best you can, subject to constraints” — and the constraints can be both financial and non-financial. Nice distinction!

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