Is Buying Stocks a Game of Chance?

Those who trade on the stock market are sometimes labeled as gamblers, likening stock purchases to visits to a casino. Sometimes, these claims may not be far from the truth. However, as always, when two do the same, it's not the same. Under what conditions is buying stocks a sensible investment, and when can it be considered a gamble?

Gambling is based on chance – here, you'll find a detailed definition of gambling, the criteria we consider most important and possible practical contradictions.

Some games, like poker, by the degree of chance vs. skill, may resemble investing in the stock market. The ability to consistently win/earn is not just a matter of luck – with an emphasis on the word "consistently" because luck (according to some, undeserved) can favor even an absolute fool.

Before the following chapters up to the final recap, you might complete the sentence "Buying stocks is okay when…".

Know What You're Doing, Where You're Going

Generally, it's advisable to invest in something you at least know something about, have basic knowledge. It's good to be prepared, have a certain awareness, even if most things are handled by a financial or other advisor (or perhaps precisely because of that?).

Recommended are classic books like Security Analysis or The Intelligent Investor by Benjamin Graham, the teacher of arguably the most successful investor, Warren Buffett.

Figure 1: Stock Market Chart (source: Craiyon)

Invest Only What You Can Afford to Lose

No one likes to lose, including on the stock market, buying stocks. However, it's necessary to consider that, especially in the shorter term (1–5 years), stock prices can fluctuate or the companies you invest in may run into trouble or even go bankrupt.

You shouldn't invest your entire life savings or funds earmarked for other things or otherwise jeopardize your existence. It's generally recommended to have a reserve of 6 to 12 times your monthly income, perhaps for the event of job loss or various unforeseen expenses.

As for the allocation of investment into investment classes (stocks, bonds, savings accounts, precious metals like gold, silver, etc.), depending on the market situation, have a minimum of 25% and a maximum of 75% in stocks, with the remainder in government bonds and other more conservative instruments (Graham) – time deposits and savings accounts, pension savings (with state contribution and tax relief), life insurance.

Those who fear a system crash (almost all developed countries in the world are heavily indebted) and high inflation or even hyperinflation can invest in (preferably physical) gold. The share of gold should not exceed 5 to 10% of your assets because gold does not bring dividends or interest. To generate dividends while having exposure to the gold market, consider investing in stocks of gold mining companies.

Figure 2: A Nugget of Gold (source: Craiyon)

"Above All, Don't Lose…", Don't Panic

"Above all, don't lose," that's how Warren Buffett once answered the question "What should an investor do?" If you sell at a loss (decrease the value of your portfolio), perhaps in panic, it will be harder to continue expanding capital, which is the goal of investing.

With stocks, it's necessary to consider that their market price may decline, but as long as you don't close your position (sell stocks), you can still enjoy at least dividends and wait until the stock price rises again. On the other hand, situations may arise when the company faces difficulties, and it's not advisable to insist stubbornly on holding stocks and rather part ways with them.

Diversify or Don't Bet Everything on One Card

The often-repeated proverb "don't put all your eggs in one basket" holds. While you can put everything on one company, and some people have indeed become rich that way, it's more of a bet on one card rather than a safe investment.

It's worth adding that Warren Buffett, who is highly selective and picks stocks of individual companies, is not a fan of diversification. On the contrary, he claims that if you come across a once-in-a-lifetime opportunity, you should load up on it. However, for less experienced investors, diversification is a way to achieve a decent (average) return and spread the risk.

Here, the analogy with gambling becomes apparent. If you have $100, you can either bet 100 times $1 or $100 at once. The second way is much riskier. It also resembles the principle or strategic game management known from poker, the so-called bankroll management (management of the stake in the game).

Diversification can be done according to several criteria, primarily geographically (American, European, Asian, emerging markets), by industry (energy, food industry and agriculture, banking), by company size (large and small companies), by company maturity, i.e., whether they pay dividends or reinvest profits in the company's growth (so-called dividend and growth stocks), etc.

In your portfolio, according to recommendations, you can have 8 to 10 companies, or you can invest in index funds, which means you invest in relatively all companies that make up a given index – in the USA, these are Dow Jones Industrial Average – DJI, which includes the 30 most significant American companies, the broader S&P500 index, the Nasdaq technology index (Apple, Google, Amazon…), etc.

Follow Current Events and the Stock Market

It's necessary to be in the picture and follow current events not only in the world but also in the financial markets. If, for example, you're considering investing in a certain industry, such as energy, it's good to know whether there's a boom ahead (growth) or, conversely, a decline. It can be influenced by various factors, including changes in legislation (taxes), technological developments (disruptive technologies), etc.

Therefore, before you invest your hard-earned money, it's advisable to study the current state of the market, the latest news, and, for example, the so-called financial statements of companies. The market, like poker, is not only about playing but also about reading the game of others.

Patience and Time in Investing

Investing is a marathon, not a sprint. If you think you'll invest money today and make a profit tomorrow, you're mistaken. It takes time to build capital. And with that comes patience. If you have invested wisely, you can sit back and wait. Ideally, in peace, without stress and panic from every stock market fluctuation. One of the basic principles is to buy and hold, not to constantly speculate, buy and sell (although this also belongs to the stock market).

Conclusion

So, is buying stocks a game of chance? To a certain extent, yes, but with a significant difference compared to traditional gambling. While in the casino, the odds are (almost) always against you, on the stock market, with a well-thought-out strategy, they can be in your favor. It's more like poker, where a skilled player can gain an advantage over less skilled opponents.

However, there are no guarantees. Investing always involves risk, and you can lose money. That's why it's crucial to approach it with caution, knowledge, and a well-thought-out strategy. If you follow the basic principles, have patience, and stay informed, you increase your chances of success and minimize the element of chance in buying stocks.

You Might Be Also Interested

• Investing in Stocks: Basics You Need to Know;
• Investment Triangle Golden Rule;
• Bitcoin: A Comprehensive Guide;
• Is Buying Stocks a Game of Chance?
• Dividend: What It Is and How to Get Them;
• Bonds: A Comprehensive Guide to Understanding Bonds;
• Gold as a Safe Haven: Navigating Turbulence;
• Price of Gold Surpassed the Historic Record from August 2020 (2023-12-04);
• Silver in Modern Society;
• Copper as a Barometer of the State of the Economy;
• Inflation: How to Protect Against It.

Based on the original Czech article: Je nákup akcií hazardem?