Nobel Laureate

Active Investors are Gamblers

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Nobel Laureate

Active investors believe they are in control. They delude themselves that they have a special understanding of the market, a superior edge over less knowledgeable investors, making them immune to disaster. The truth is that all investors can access the same information as professional money managers through the Internet and many other sources. Still, many investors believe they are smarter and more sophisticated than the average investor. Those under this illusion fail to realize how much investment performance depends on luck. Most of them eventually pay dearly for this mistake.

Active investing in the stock market is a lot like casino gambling. Take a look at the numerous comparisons in the various news articles below. (Note the references to addiction.)

  • Las Vegas Review-Journal; June 29, 1998, SOS: STUCK ON STOCKS. "By far, the most gambling performed in the world is performed in the stock markets," said Paul Ashe, president of the National Council on Problem Gambling. "More money is lost in the stock market than in legal and illegal casino gambling combined," said Marvin Steinberg, a Connecticut psychologist who specializes in treating compulsive investment gamblers.
  • Northern New Jersey Record: February 2, 1998, High-Risk Investments Online Internet Trading Can Be Addictive and Costly. Dan Gaffney liked the odds. A $1,200 wager, a $150,000 score. He came so close to winning, too. But somehow, he lost. And it didn't feel like losing $1,200. It felt like $150,000 had just slipped through his fingers.
  • ABC NEWS, February 1, 1999; The Craving to Buy and Sell; Online Trading Becoming Addiction for Some
  • San Francisco Business Times; Options junkies get treatment as chronic gamblers
  • January 25, 1999, this article titled "Stock Market Gambling" and Stock Market Gambling and The Addiction Of The Millennium
  • See 20 Questions for Compulsive Gambling - Note Stock market check box at the bottom
  • The San Francisco Chronicle; August 16, 1999, Losing Your Shirt For Day Traders - For those risk-loving hunters of the stock market, gambling is the essence of their trade
Fidelity Outlook

Fidelity Outlook, Summer 1999; Cover Story, The New Psychology of Investing; Obsessive, Compulsive, and so far Successful

Forbes, Addicted to Click

Forbes, September 13, 1999: Addicted to the Click, How my on-line trading frenzy ended in a lingerie department in Paris

Wrapped up in Risk

San Francisco Examiner; Wrapped up in risk; Compulsion to gamble can blind even the best investors to bets gone bad

The active investor's addiction to beating the odds is often as strong as any other addiction. Like gambling, active investing can be extraordinarily exciting for investors who get carried away by the adrenaline of winning. Of course, it can create significant agony for those who experience the losing side of risk. One of the biggest mistakes made by the active investor is believing there is skill involved when the stock market proves profitable. Many of today's day traders are learning this the hard way. There are now approximately 15 million online trading accounts in the United States. Stories of mounting losses are becoming more prevalent as the odds of playing the markets take their toll on this new breed of investors. Just like casino gambling, there are more tales about the winners than the losers, but the stories rarely give an accurate accounting of true net profit.

New studies in the field of neuroeconomics confirm the release of dopamine when presented with the opportunity of a surging stock. This validates and confirms the addictive nature of Stockaholics™. The powerful allure of monetary reward leads to the overwhelming urge to trade stocks or funds. It has now been shown through brain imaging studies that the circuits that switch on at the prospect of big profits are the same as the ones that lead to the addictive nature of cocaine, casino gambling, alcohol, chocolate, and sex, just to name a few. The brain images below tell the story.

expecting dough vs. expecting dope

In the October 2002 issue of Money Magazine, the highly respected journalist Jason Zweig writes a ground-breaking article about the new evidence of the release of addiction related dopamine in our brains. He declares, "the dopamine rush we get from long shots is why we play lotto, invest in IPOs, keep too much money in too few stocks and invest with active portfolio managers instead of index funds." He goes on to say that, "our brains are wired to force us into forecasting; it is a biological imperative. In fact, humans are born with what I've come to call 'the prediction addiction.'" Zweig reports that there are several researchers working on nueroeconomics at this time. At Harvard, Hans Breiter is leading a project and has stated that they have discovered a "striking" similarity between the brain's reaction to cocaine, morphine, and the prediction of financial rewards. Please take the time to read Jason's new book on this subject, Your Money & Your Brain. Also see Center for Neuroeconomic Studies Duke University.

Meir Statman talked about his new book, What Investors Really Want: Know What Drives Investor Behavior and Make Smarter Financial Decisions, on When asked about index funds, he stated, "Well, index funds are fabulous. Now you say well can I do better than average? Can I perhaps exploit other people's cognitive errors? And the answer to that is probably yes. But the question really is how much does it cost you to exploit the cognitive errors of the others. Think about somebody who says there are $100 bills some place in the streets, so this is the equivalent of a cognitive error of other people, because they have left it lying down. Well, but it will probably take you three days to find that one $100 bill, if that. And so you're going to waste too much money looking to exploit other people's cognitive errors, and in the process you're going to really shortchange yourself by getting lower returns."


behavioral biases


In this new report from Barclays, The Role of Control in Financial Decision Making, the emotional mistakes investors make have been discussed and analyzed.