Forex & Gambling
Posted in Forex Trading on November 21st, 2006Last week I took a trip to Melbourne with friends to watch U2 play live in concert.
While the concert was something that I’ll never forget, but one odd memorable moment of the weekend was spent in the Crown Casino.
After wandering through the casino and seeing the multitudes of pokie machines and playing tables we sat down for a coffee.
As the conversation talked about our immediate surroundings it soon turned to what I did.
“Ryan, you say that forex trading is different from gambling, how so?”
“Well let’s have a look,” I answered, “and compare both.”
We looked out at the old ladies pushing the flashing buttons and began.
“We both need money to play, right?”
One friend nodded.
“We both have an element of risk. For a forex trader this can either be their stop loss for each trade or their entire account. For the pokie player whatever they put in they are prepared to lose.”
“Yep,” they all agreed.
“We both have an uncertain element of reward. Even if a forex trader uses limit exits they don’t know whether that will ever be hit. Same for the gambler.”
“Mm-hmm.”
“Not even having a system differentiates between both: I’ve seen systems sold by people to make money from Lotto, or on the tables, or horses.”
“So you’re a gambler then?” they all asked.
“Well there is one thing that differentiates us.”
“What’s that?”
I knew they wouldn’t understand the terminology I was going to use as the answer so I used a simple illustration.
“Let’s say that I find a game at the Crown that allows me to make $1 if I can call the flip correctly, but I’ll lose $1 if I call it incorrectly.”
I stopped making sure they understood - they did.
“Now let’s say that I flip away all night and end up tossing the coin 1,000 times. On average, how much do you think I would make at the end of the night?”
“Well,” spoke up one hoping to impress his woman, “you’ll have roughly a 50% chance of calling the correct face each time. Therefore you’ll win about 500 times out of the 1,000 and you’ll lose on the other 500 times.”
“Yep, that’s right, so how much have I made or lost?”
“Well… if you’ve won 500 times that means you’ll win $1 each time, therefore making $500, but you’ve lost 500 times and you’re going to lose $1 each time, meaning you’ve lost $500, resulting in making nothing… and losing nothing.”
“Good!” I was impressed, so I decided to modify the illustration slightly, “Let’s say you find the same type of game but it pays $1.10 on a correct flip, and $1 on an incorrect call. What’s likely to happen after 1,000 flips, now?”
Again the same friend decided to take the new challenge.
“Ok, you’ve won 500 times and you’ve made $1.10 each time, therefore you’ve made $550. The losses are the same as last time, being $500, therefore you’d profit $50.”
“Well done!”
“But I still don’t see the point between forex trading and gambling,” said another frustrated that he wasn’t quick enough to answer yet annoyed that I hadn’t answered the question.
“How many times would you play that first game?” I asked.
No one wanted to play the first game.
“How many times would you want to play the second game?” I asked.
A couple jided on how crap the returns were, but all agreed that they’d play it.
“What you’ve just done is proven that you’re not a gambler. You’ve just calculated your expectancy for both games. In essence expectancy is just the probability of winning multiplied by the amount of your win less the probability of losing multipled by the amount of your loss.”
A joke was made, and the conversation turned to a little less technical matter.
“Yep, he’s a gambler,” they all laughed.
Unfortunately what my friends failed to understand was that all games in the casino have a negative expectancy. You might win at the start, but the more you play the greater your chance of giving it all back and losing it all - which is why the casino does as much as it can to keep you playing.
So, do you know your expectancy?