Trading is based on the anticipation of stock market price movements. To the uninitiated, it may seem like a simple game of chance.
“The majority of people trade worse than a purely random trader would". This quote from the American trader and fund manager William Eckhardt addresses the purely random aspect of stock market investing. Unless he means that professional traders, once their strategies are set up, have only to apply them mechanically to generate capital gains for sure? What is the place of chance in trading?
Here is a comprehensive summary of the information you need to understand how chance influences trading performance.
First of all, it is obvious that the results of trading as an investment activity are never 100% guaranteed. A trader can never be totally sure of the future behavior of an asset on the financial markets. Chance is always at work.
Trading requires psychological stamina similar to that of a casino player. Both traders and gamblers are aware of the inevitability of loss, an inherent part of their activity. The stress of investing in the stock market is similar to that of gambling.
In this parallel with gambling based on chance, betting is also present in trading, which involves investing (and therefore betting) a certain amount of money, in the hope of getting more in return. This possibility of winning or losing, without being able to know the outcome with certainty, underlines the random nature of the activity.
In addition, a certain amount of trading practice generally reinforces the perception of the uncertainty factor. Indeed, novice traders (without the necessary funds or knowledge) tend to place their orders on the markets based on :
This behavior, very similar to that of gamblers, usually stems from the idea that it is possible to get rich quick through sheer luck.
Finally, this impression of randomness is reinforced by "black swan events": i.e highly unlikely events with huge short-term impact on the financial markets. For example, in the case of a declaration of war between two states, the repercussions on financial asset prices can be immense.
Even among gamblers and bettors, the most experienced have strategies that they follow carefully in order to minimize risk.
The more they progress, the more traders uses stratagems such as :
This allows the investor to reduce the uncertainty inherent in trading as much as possible, and to secure themself against losses.
In addition, seasoned traders have very good knowledge of the assets in which they invest, as well as the market in which they specialize (currencies, stocks, commodities, etc.). They follow financial news and major events of the sector via the economic calendar, in order to anticipate the price movements as well as possible.
As a result, trading can be done in a much more scientific way than gambling based on luck. This is especially the case when traders use technical analysis: through certain indicators, investors are able to determine whether or not the circumstances are favorable before taking a position in the markets.
Furthermore, while gamblers can risk their entire capital on one bet, relying on luck, traders usually strive to diversify their investment portfolio. Fund management is one of the basics of trading, where betting everything on one trade makes no sense.
Luck is always present in trading : an investor, no matter how experienced, will never be able to know exactly all of the innumerable factors influencing stock market prices. However, true trading consists precisely in limiting the chance factor as much as possible, by implementing a certain number of scientifically based strategies and practices, in order to increase capital gains.