Gambling vs. speculation:
what differences?

Roulette vs. market

Gambling and speculation have some common traits.

But gambling produce risks created by the game itself while speculation
transfers existing risks and uncertainties.
Also the part played by mathematic probability vs. human uncertainty
is different.

Speculation is anticipation and risk taking, some excesses can easily
occur, but it is far from the demonized activity that various activists
consider wise to present in support of their agenda.

The man and the lettuce
 
You might be surprised, the secret is well hidden, but
dice speculation is an everyday activity
                  done by about everybody.
That is if we call speculation any human decision and behavior which:
* rests on the telescope anticipation of possible future events (*).

* knowing that some of those imply risk risk

* but could bring box benefits
(*) In that sense of projection into the future and behaving accordingly,
      speculation is a trait that makes human beings differ from lettuces. It
      is
hardly present in other parts of the physical, animal or
      vegetal world
.

Gambling, on the other hand,
deals with moves in which risks and gain
possibilities are created by the game itself, while the risk did not exist before
the gamble.

Focus on sous financial speculation

This article:
*  focuses on a specific area
of speculation: financial and
    economic speculation.
* also, tries to see what relations it has or not with money
   gambling.


Both gambling and economic / financial speculation are about getting a
monetary reward in counterpart to taking a monetary risk
.
But, beyond some similarities between those "games", there are
important
differences between roulette betting and market playing:

Gambling and probabilities

In gambling, notably organized gambling, the probabilities of gains
and losses are usually fairly well known.
They are normally ...against the gambler.
This is how casinos and lotteries survive. Comfortably it seems.

Also, in gambles in which only random laws apply, there is few
room left to use cognitive abilities to make anticipations.
To get back to our allegory used in the introduction, a lettuce
(with an embedded trading software) can play with the same
result than the usual bet taker...although it might not draw
from it the same
( pleasure happy or  pain sad)  emotions,
which are a crucial gambling ingredient.


Better not conclude that lettuces (or trading computers), just
because they are immune to emotions, are
...
rational beings.
Of course some types of betting (card playing, horse races, election
predictions) are not uniquely driven by known probabilities as they
suppose deductive / anticipative strategies.

Speculation and anticipation 
under uncertainty

A) Anticipation as the main trait

Speculation is a mode of decision making based on anticipations of
what the future can be.

In economic / financial speculation
, the main differences with
gambling are that
  • The risk is already existing but transferred between persons
(a bit like in an insurance contract),
while in gambling it is created by each bet.
  • Probabilities are only indicative in speculations,
On the contrary they are precisely known in some types of
gambling (...and insurance).

Many speculative decisions, in fact most economic / financial decisions,
are taken under
fog uncertainty (= a non measurable risk).
Anything can happen, in such "dynamic systems", if only because of the
human factor (how will people think, feel, react and behave?).

=> In such cases, the future is not fully linked to statistical probabilities
      and mathematical models have their
limitations.

Therefore anticipation with multi scenario building on economic
evolutions are essential for deciders entering a financial speculation
Careful, speculation is not the same thing than rigging the market,
even  if some people confuse the two words.

See poach 
financial deception.

B) The clock time horizon as a crucial factor

There are differences between forms of financial speculation, linked to
their time horizon:
  • clock Short term trading,
a typical form of speculation is, we better say it, a dangerous
activity in which most "players", and notably amateurs, end
up losing money.


When that sport is presented
as a "make big money easily
and fast" scheme.
it is no more speculation but fraud.
  • plancalend plancalend Long term investing,
If has to be done with some precautions
(but can it be called speculation?).

It is usually based on the idea that investors can
- after a long 
enough time -
get a better return  from risky assets
(stocks notably) than from riskless ones
(savings
accounts, treasury securities...).


This extra expected return is what makes the
risk premium.

A popular way to do it is to invest in funds which portolio reflects
directly (index investing) or with some corrections (smart
beta
) the evolution of a stock index.

General comparison gambling - speculation - investment

The comparison can be done as follow

Types >

Traits
   v

dice
Gambling

Financial
Speculation


Investment

Risk nature

Inexistent risk
before the bet
The bet creates
the bet

Exchange between a
buyer and a seller of
existing situations that
entail a risk and a
potential reward.
Either creation of risk 
/ reward situations
(business creation) or
more often exchange
of such situations
Probabilities
Odds usually known
in some types of
gambling
Some probability tools might be applied but
the basis is a general uncertainty.

Time horizon

Short term usually

Long term

Social
environment
Leisure, hobby

Economic / financial
fluctuations and liquidity
Economy, business
financing
Psychological
drive
Fun, greed, fear or
addiction. In some
cases (card play)
challenge / competition
/ mind training.
Greed, fear,
challenge, curiosity,
status or addiction


Savings, long term
safety, challenge,
economic curiosity


Effects of economic / financial speculation

Financial speculation is sometimes deviltail demonized as the mother
of all economic evils.
Activists find it useful for their agenda to confuse it with economic
exploitation and market manipulation.

This article shows what it is really, an application of anticipation and risk
taking.
It also bring insurance against risk to the counterparts.

But of course excesses might take place, and there is a never ended
debate whether economic / financial speculation:
  • Stabilizes  equil markets:
Speculators are supposed to correct market anomalies, by
buying underpriced assets and selling overpriced ones.

They are also, except when things turn bad, the key provider
of market
liquidity  liquidity (= the permanent availibility
of buying or selling counterparts)
.
  • Or destabilizes spiral them
when traders (or their robots programmed as such !) act irrationally
(see
behavioral biases), often out of mimicry, and lose sights of
the fundamentals and of the real prospects
of the assets
they trade.


One day reality comes back with a revenge. 
Periods of general
greed / exuberance or fear / panic create
bubbles and
crashes.

Of course it is a matter of situations.
Speculation has less effects on markets on which the anticipation
chain has to be settled in the end by physical deliveries against
cash
, than on "soft" markets (financial markets).
Also, whatever its effect, speculation acts as a
temperature thermometer of
financial and economic issues.
Speculative excesses should be watched not only for themselves but
more important
to detect what economic imbalances are behind.

Financial speculation is often diabolised. Many people assimilate it mentally
to market manipulations and excessive risk taking (overleverage) that can
endanger the economy (often made easy by loose budgetary and monetary
policies). Those excesses should be monitored and condemned..


Here comes a current issue: are bank traders' bonuses OK?

Should they play with my money and get the reward
...while leaving me the risk, as a depositor?

See the related article:
Are bank traders' bonuses perverse incentives?

Sources and further reading
Behavioral finance glossary

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M.a.j. / updated : 02 Sept 2015
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