The Casino Mentality In Trading

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Alan Farley

26 Sep, 2018

in Psychology

Financial markets attract all sorts of participants, from part-time hobbyists looking for extra cash to multinational institutions moving billions of dollars across thousands of instruments. The trading game stretches across both ends of the spectrum, with part-timers and at-home gamers competing for profits with traditional funds and lightning-fast computer algorithms.

Data suggest the majority of traders playing at the shallow end of the market pool will eventually fail at the endeavor and pick up stakes, letting someone else manage their money, or simply giving up and looking for another way to build wealth. Ironically, many of these folks never had a chance to succeed because they came into the game with a casino mentality that marked a direct path to failure.

What exactly is a casino mentality and how does it undermine the trader’s quest for profitability? Is this flawed approach limited to novices or do experienced traders also get caught up in the behavior? What’s the most effective way to overcome the casino mentality and replace it with a disciplined approach that supports a profitable career in speculation?

Defining The Casino Mentality
Many new traders view their participation in the financial markets in the same way as a trip to Las Vegas, hoping the pile of cash in their back pockets can be traded in for a bigger pile when they leave. Many of these folks haven’t learned basic trading strategies and techniques because they are oblivious to the nature of risk, hypnotized by the greed that sticks like glue to all get-rich-quick schemes.

The media and peers have programmed new traders to look at securities as betting sheets and the broad market as a sporting event, in which anyone can win as long as they root for the right side. The game looks black and white from their perspective, because they don’t understand how markets pick the pockets of traders who throw money at securities with the same intensity that coins are dropped into one-arm bandits in hopes of hitting the jackpot.

And just like a slot machine, minor pay outs at regular intervals increase the motivation to place bigger bets, whether or not they are appropriate to the market conditions and opportunities in play at the time. This greedy behavior occasionally pays off with a big win but mostly loses money consistently over time, opening the door to failure and a final exit from the trading game.

The lack of a definable edge seals their fate just like gamblers who play for excitement but fail to learn the odds for each game and appropriate responses that reduce or eliminate the house’s advantage. Meanwhile, both sets of individuals get secondary reinforcement for destructive actions because their bodies release adrenaline and endorphins whenever they play, regardless of winning or losing.

The casino mentality consumes the most capital when markets or instruments head into binary events, like earnings reports or economic releases that trigger sharply higher or lower security prices. Smart traders step aside or hedge positions at these inflection points because they don’t know the outcome and guessing doesn’t constitute a viable strategy. Meanwhile the afflicted trader goes all in, taking large positions because they are fixed on the winning side of the equation, blind to the significant cost of being wrong.

Beginner’s Flaw or Lifetime Affliction
The casino mentality primarily affects novices because it is a natural consequence of misunderstanding the financial markets and how they function. Many of these folks will learn from their mistakes sooner or later, using the inevitable losses as a wake-up call to take the subject matter more seriously. In turn, this provides the motivation needed to sit down and learn the basics of strategy, position sizing, positive expectancy, and risk management.

While novices wash out quickly if they don’t abandon the casino mentality, experienced traders can carry elements of this destructive mindset for years. While it doesn’t dominate their time-tested strategies, this mentality can show up whenever greed overcomes discipline. It isn’t fatal in small doses and may inject a bit of fun into the trading day, as long as position size is kept down. These are appropriately called “lottery tickets,” working best when traders face binary scenarios they’ve seen enough times to believe they have a better than 50-50 chance of being right.

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