Gambler's Ruin
2012-04-07
The reason why on average gamblers can never win over a casino is explained by the theory called Gambler's Ruin. Google it if it doesn't sound familiar. It basically means that the winning probability for one side to play in a fair game against the other is depend on proportion of one's capital against the other side. So in the case where casinos talk about billions of dollars, whereas individual gamblers are only betting some millions or even less, the probability for gamblers to win is pretty much very slim. The only chance you could possibly beat the big money guy, is to have a predetermined amount you are willing to lose or walk away with and stick to it no matter what.
In many ways, Wall Street is similar to casinos: they are rich, powerful and sort of un-beatable. Those people who think they have beaten against Wall Street in one way or another have two things to thank for:a) luck; b)self-control. Now there is another factor to allow them to do so: leverage.
Think of leverage as a weapon to break up Gambler's Ruin: with leverage, even a bullet can be turned into a grenade. But leverage is also a double-blades sword: it increases Gambler's probability to win, yet if it blows up, Gambler can't really afford the loss. That's the "beauty" of the modern day Wall Street, at least prior to 2008. Not only the investors were leveraged, many banks themselves also joined the club. Until the music stops, everyone was enjoying the party and couldn't hear the voice out there calling to crash the party. Just like how people hate party crashers, Wall Street also treats people on the short side with hostility, for the simple reason that they think they can rule the world. First, they could not care less for the weak voice because it is too weak and they are too strong. Next, they try to bury the voice by being a biased referee and player at the same time. Finally, when the double-blades sword eventually gets to the big guys, they played "too big to fail" and kidnapped tax payers to save them.
What Wall Street has been doing to make money was to apply the probability rule and turn every gambling into its favor by playing with unlimited stakes. Having said that, you may still be able to win only if you are a)lucky and b) self-controlled. It is never too late to be superstitious sometimes :)