Is the Stock Market Guilty of “Casino Capitalism”?

Casino Capitalism

Ralph Nader is at it again, and he’s now accusing the stock market of promoting “casino capitalism.” Could it be that Mr. Nader is starting to figure out this a little more?

Ralph Nader noticing that the stock market is like a casino might be one of the funniest remarks ever made about it. The joke is lost on a great many people though, and when we look at what secondary stock markets consist of and the function that they perform, how could anyone miss this?

The problem is that not a lot of people know what the role of secondary stock markets really is. We need to ask what else they could be besides a place to make bets on things, and given that this is the only thing these markets do, if we strip away the betting, there’s simply nothing left.

This is what makes his remarks so funny, as this would be like saying that sports betting is nothing but people making bets on games but thinking it is something else instead, without even knowing what this other thing might be. The entire secondary securities market is just a place to bet on financial securities, and there’s not a single thing traded that doesn’t work this way, whether this be stocks, bonds, options, futures, collateralized debt, or anything else.

If you are going to be betting on these things, it obviously is helpful to know what you are doing, and not pretend that your bets aren’t just bets and are something else, even though we may not be sure what else they could be.

This might not seem to be a very meaningful distinction at first glance, but not seeing that this is just all betting is behind the huge amount of misunderstanding that pervades investors. Since this issue is at the heart of what we do when we invest or trade, what we are even doing here, getting this wrong is going to in itself take us well off track.

The use of the term casino might appear to be derogatory, where someone may not like betting and is accusing the stock market of engaging in gambling, but it is gambling pure and simple, and if you don’t like gambling then you shouldn’t like betting on financials. If you are not in favor of gambling but you invest, and you pretend it isn’t gambling but something else, and try to understand what you are doing by trying to portray it as something it is not, this is what you call not knowing what you are doing.

We need to step back and look what taking positions in securities involves. You see a security being offered for sale at a certain price and you buy a certain amount. You bet $1000 on the price going up, and if it does go up, you win the bet by the amount it rises, and if it instead goes down, you lose your bet by the amount that the price falls.

What else could this possibly be other than placing bets? The funniest thing about all this is that those who somehow are confused by this think that it is instead something else, but given that there isn’t anything else it could possibly be, they are instead left to believe in nothing. Even people who believe in the tooth fairy have at least defined their belief.

We are left to completely wonder what Nader thinks the stock market is other than his characterization of it being casino capitalism. We may argue that using the term casino isn’t that appropriate given that casino games involve a mathematical disadvantage for bettors, and some people object to this and see casinos bilking people by taking advantage of what is seen as irrational behavior, where all the bets are bad ones and no one seems to care.

While there are surely some casino gamblers that don’t understand that the odds are stacked against them, this is extremely well known, and people still do it for its entertainment value. The best we can do is try to inform them that this is not a favorable situation overall from a probability standpoint, and then if they still want to spend their money on this, it is their money.

The betting in the stock market is the complete opposite of this, where given that stocks go up a lot more than they go down, you can place bets on the long side with them and receive tremendously favorable odds. If we insist on using the term casino here, we need to understand that this casino is entirely different from the places we normally call casinos, with the only thing in common being the placing of bets.

However, this concern doesn’t factor into the matter, as when we call the stock market a casino, we aren’t referring to people being taken advantage of mathematically, we use it to describe a place to wager money at, and that part completely fits stock markets and other financial exchanges.

Investing and Trading is Gambling, Pure and Simple

We also need to clean up the use of the term gambling here as well, given that we often use gambling in a negative connotation. People have a problem with gambling not because they gamble, but because they gamble with a negative expectation. If the expectation were instead positive, making a lot money wouldn’t be considered a problem, like losing a lot of money is.

All gambling that doesn’t involve a structural disadvantage that casino games have involves various levels of skill. You can have a positive expectation with sports betting or poker, but these are zero sum games that you need enough of an advantage over other bettors to make a profit net of costs, which is the take that those offering the betting keep for themselves, the vigorish with sports betting and the rake with poker.

We have the same thing with financial betting, and even if you can trade commission free, you still have to pay the spread, the difference between what you can buy something for and what you can sell it for. There always needs to be a house because someone needs to bring these bettors together, and they need to cover their expenses or go out of business, and there also needs to be an expectation of profit otherwise there would not be any incentive.

There are some types of financial betting that are zero sum games, called derivatives, which are basically side bets where there are two active parties in the bet, where if one makes money, the other loses the exact amount, giving us our zero sum less trading costs. This is even the case with index futures, even though they involve stocks which have a strong upward bias.

With trading stocks on the stock market, if you buy a stock and it goes up, the person who sold you the shares missed out on potential profit, but they did not lose money in the real sense. They may have themselves sold for a tidy profit and just stepped away and handed the ball to you and you ran with it some more.

Here we have two participants who have profited nicely, where if we instead take a long position in S&P 500 index futures, every dollar we make will come directly from the account of the other party, who remains active in the trade or hands it off to someone else that you will take money from instead as your position gains value, or give your money to if your position moves away from you. These bets are settled once a day where everyone pays up.

This does not mean that we cannot enjoy the same positive expectation on the upside that owning stocks involve when we trade index futures, and they therefore can be traded with considerably less skill than options trading requires for instance, it just means that futures trading in itself doesn’t provide any net gains in wealth and instead just distributes money that is bet, according to the results of the bets.

How we are able to make a lot more money from trading index futures without much skill, even though it’s a zero- sum game ultimately, is because not everyone is in it to make money, and those who instead are looking to hedge are happy enough to pay the price of negative expectations to protect themselves against risk, whether these bets ultimately make enough sense or not.

If we are up 20% in a futures index trade, someone has lost this 20%, perhaps being spread among several other parties. With stocks, while we could say that the other side of our trade has lost 20% as well, what is being lost here is potential profits, not real money. The bettor who sold their stock is happy enough to part with it and sell it to a market maker.

The market maker who sold us the position doesn’t even care about what happened before or what is to come, this, as they make their money from the spread and happily take these very small profits over countless trades like a sports book would with their spread or a poker room would with their rake.

In theory, every single participant at a stock casino could be profitable, if we see the price keep rising and everyone being long and making money, with the market makers also making a good profit for their role in facilitating all these trades. People do lose money in stocks of course, but the skill level required to make money with stocks long-term is practically zero, as you can just take a position and do nothing and be in a great position to do well regardless of the hills and valleys that the journey may take.

Those who do have the right skills can do even better, where they can both time their positions in accordance with how the money is moving, as well as increase the size of their bets substantially to better leverage their skills by trading futures, where they don’t even own stocks and are just making bigger side bets with other traders.

The Direction of the Betting Is the Only Thing That Moves Stock Prices

We might want to call this all a casino, but this is a very different sort of casino than what we normally use the term to describe, yet it is still a casino in the existential sense, where casinos are places to bet at, although a much more friendly one than the ones where games such as blackjack and roulette are bet on.

This is because the definition of a casino is a place where people place bets on things, whether this be on bets of chance with the odds against you or betting on stocks with the odds greatly in your favor. We can still classify these places in terms of the quality of the expectation and the skill level required to achieve a good positive expectation, where the stock market casino is at the good end of the scale, and the traditional casino being at the other end.

Your kids could even bet on stocks and do well, even if they knew nothing about them other than perhaps seeing some commercials on television. They could plop down their allowance on a stock or even pick an index and just hang on until they are older and see their money grow. Even if we get a bear market, stocks get through those and continue upward overall, so this is a bet that takes no real skill and has great odds.

Calling the stock market a casino is therefore nothing that anyone should find objectionable, especially since this is also completely accurate. We might think that trying to understand it differently shouldn’t really matter, but it does matter a great deal as it turns out, and is the ultimate bane of the confused investor and analyst.

Unless we understand that what goes on with stocks is simply betting, we will miss the fact that the direction of the betting in itself runs the show, not just partially but completely. It is not that speculation interferes with stock prices, as they are purely derived from various levels of speculation that goes on.

We’re not even sure what this would be other than speculation, which is another term for placing bets to speculate on future stock prices. While people also own stocks to hedge, this is very unusual with stocks and just about everyone is betting that prices will continue to rise. People short stocks but that means that they are betting the price will go down. If this isn’t speculation, and it surely isn’t hedging that is supposed to provide the alternative reality here, but aside from these two things, we are left with nothing else this could be.

When we look deeper into what else that they might be thinking stock bets might involve, it turns out that they think that the betting should proceed in a manner that they think it should, like being based upon how many cars a year you sell. This is the biggest mistake people make by far in trying to understand stocks, taking views that do not correspond with reality and then complain that what happens does not conform with their opinions.

Bettors can bet however they please though, regardless of how much or how little profit a company may make or even if they are losing money. We could take a stock right up to the sky, Tesla being worth a million dollars a share for instance, and there is nothing that could stop us from doing this if we wanted to.

Tesla took a tumble on Wednesday, but it wasn’t the company admitting that the coronavirus may delay production, it was the bettors hearing this and choosing to alter their betting patterns accordingly, which they do to the extent they see fit. Their beliefs are the only thing that changes prices, although few understand this properly because they have their eyes shut and their heads in the clouds.

When we try to make predictions based upon external events alone, we at least need to realize that we are just making guesses here as to how the betting will proceed. When our guesses are wrong, it’s the guess that is wrong, not what actually happened in the market which are called the facts. Everything happens through the market’s eyes, and trying to pretend that the proximate cause of price changes is something else is simply factually incorrect, which we can only appreciate when we properly understand what goes on as betting.

Bettors are behind the wheel of this car, and if they don’t take the route that we expect them to, we are simply left being wrong. If we base our strategies on opinions that are fundamentally disconnected from reality, like making an assumption that stock prices are intrinsically limited by anything other than supply and demand for them, and ignore this supply and demand which isn’t just the main thing, it’s the only thing, we are acting stupidly, and will invariably look the part.

The stock market is indeed a casino, and what happens in the stock market is nothing else but casino capitalism, but if we try to pretend otherwise, this takes us in the completely wrong direction if understanding is the goal. We cannot expect to do well doing something that we do not understand and have no interest in understanding.

We use the term investing to describe it, without bothering to wonder why we call it that, but none of this is actually investing, which is defined by placing capital in the economy and looking to profit. Stock trading doesn’t involve any investing though, so we actually should look to lose that term and call it what it actually is, securities betting, which should at least serve to make the whole thing a little more transparent.

All the stock market does is allow people to bet on stocks, nothing more or nothing less. People will put their money on various things and it is this betting itself that decides everything. If we try to look upon this fundamental truth with disdain, if you don’t like reality, and choose to distort it, your results will be distorted as well. On the other hand, if you get that this is all just betting, and set aside your confusion, now you are in a position to decide much better.

Ralph Nader may complain about this, and even though some of this is sinking into his brain more, he’s still obviously fighting it, still thinking that is supposed to be based upon something else, his ideas apparently. The real problem is that just about everyone thinks the same way Ralph does, and realizing that people are acting like it is a casino is just the first step, where we hopefully may one day realize that this is exactly what it is.



Robert really stands out in the way that he is able to clarify things through the application of simple economic principles which he also makes easy to understand.