Speculation vs. Gambling: An Overview
Speculation and gambling are two different actions used to increase wealth under conditions of risk or uncertainty. However, these two terms are very different in the world of investing. Gambling refers to wagering money in an event that has an uncertain outcome in hopes of winning more money, whereas speculation involves taking a calculated risk in an uncertain outcome. Speculation involves some sort of positive expected return on investment—even though the end result may very well be a loss. While the expected return for gambling is negative for the player—even though some people may get lucky and win.
Speculation involves calculating risk and conducting research before entering a financial transaction. A speculator buys or sells assets in hopes of having a bigger potential gain than the amount he risks. A speculator takes risks and knows that the more risk he assumes, in theory, the higher his potential gain. However, he also knows that he may lose more than his potential gain.
For example, an investor may speculate that a market index will increase due to strong economic numbers by buying one contract in one market futures contract. If his analysis is correct, he may be able to sell the futures contract for more than he paid, within a short- to medium-term period. However, if he is wrong, he can lose more than his expected risk.
Converse to speculation, gambling involves a game of chance. Generally, the odds are stacked against gamblers. When gambling, the probability of losing an investment is usually higher than the probability of winning more than the investment. In comparison to speculation, gambling has a higher risk of losing the investment.
For example, a gambler opts to play a game of American roulette instead of speculating in the stock market. The gambler only places his bets on single numbers. However, the payout is only 35 to 1, while the odds against him winning are 37 to 1. So if he bets $2 on a single number, his potential gambling income is $70 (35*$2) but the odds of him winning is approximately 1/37.
Although there may be some superficial similarities between the two concepts, a strict definition of both speculation and gambling reveals the principle differences between them. A standard dictionary defines speculation as a risky type of investment, where investing means to put money to use, by purchase or expenditure, in something offering profitable returns, especially interest or income. The same dictionary defines gambling as follows: To play at any game of chance for stakes. To stake or risk money, or anything of value, on the outcome of something involving chance; bet; wager.
Speculation refers to the act of conducting a financial transaction that has a substantial risk of losing value but also holds the expectation of a significant gain or other major value. With speculation, the risk of loss is more than offset by the possibility of a substantial gain or other recompense. Some market pros view speculators as gamblers, but a healthy market is made up of not only hedgers and arbitrageurs, but also speculators. A hedger is a risk-averse investor who purchases positions contrary to others already owned. If a hedger owned 500 shares of Marathon Oil but was afraid that the price of oil may soon drop significantly in value, he or she may short sell the stock, purchase a put option, or use one of the many other hedging strategies.
While speculation is risky, it does often have a positive expected return, even though that return may never manifest. Gambling, on the other hand, always involves a negative expected return—the house always has the advantage. Gambling tendencies run far deeper than most people initially perceive and well beyond the standard definitions. Gambling can take the form of needing to socially prove one's self or acting in a way to be socially accepted, which results in taking action in a field one knows little about.
Gambling in the markets is often evident in people who do it mostly for the emotional high they receive from the excitement and action of the markets. Finally, relying on emotion or a must-win attitude to create profits rather than trading in a methodical and tested system, indicates the person is gambling in the markets and is unlikely to succeed over the course of many trades.