Trading and Exchanges Chapter 8: Gamblers, Speculators, and Fools in the Market (Part 2)

In Part 1 we covered the “normal” reasons people trade: investing, borrowing, exchanging assets, hedging. Those are utilitarian traders who use markets to solve real-world problems. Now we get to the uncomfortable half. Gamblers, speculators, fools, and everyone in between.

Gamblers in the Market

Harris is blunt. Some people in the stock market are just gambling. They bet on price movements the same way someone bets on a horse race. They don’t have information, they don’t have analysis, they just want the thrill.

Here’s the thing that makes this awkward: most gamblers in financial markets don’t know they’re gambling. They think they’re speculating. They think they have an edge. Harris says you can spot them by their enthusiasm for trading and their inability to clearly explain why they expect to win. Sound like anyone you follow on Twitter?

Harris even compares off-track betting shops to retail brokerage offices. Same TVs showing the latest action. Same people sharing “tips.” Same energy. That comparison stings if you’ve ever sat in a day trading chat room.

Gamblers tend to trade too often, pick overly volatile instruments, and take on more risk than makes sense. If they’re also investors or hedgers on the side, the gambling habit bleeds into everything and makes it worse.

One interesting point: gambling is not necessarily bad for markets. Since gamblers are uninformed, they lose money to well-informed traders. This makes informed trading more profitable, attracting more smart money. More smart money means more accurate prices. So gamblers subsidize price discovery. Thanks, gamblers.

Fledglings: The Expensive Tuition

Fledglings are people trading to find out if they can trade profitably. Think of it as an internship where you pay with your own money.

Harris tells a classic story. Brad paper-traded for years and beat the market consistently. So he quit his job to trade for real. After a few months of real losses, he went back to work “a much wiser, but less wealthy, man.” Paper trading is not real trading. When your actual money is on the line, your brain does different things. You get emotional. You hold losers too long, cut winners too short.

The stats are brutal. Harris says traders commonly report that fewer than 5 percent of fledglings survive to trade profitably. 95 percent wash out. And here’s the sneaky part: some of those who “succeed” might just be lucky. You can’t easily tell the difference between skill and luck, especially over short periods. A successful fledgling might still be a fledgling.

Cross-subsidizers and Tax Avoiders

Quick mentions. Cross-subsidizers are professional money managers who trade extra to generate commission revenue for their brokers in exchange for research and services. It’s called soft dollars. They’re basically paying for Bloomberg terminals with your trading costs.

Tax avoiders trade to exploit loopholes. Harris gives a strategy called “harvesting losses.” Hold individual stocks instead of an index fund. At year-end, sell the losers to book capital losses against your taxable income. Never sell winners. Over many years, this adds up.

Profit-Motivated Traders: The Sharks

Now we get to the professionals. Profit-motivated traders trade only because they expect to make money. They come in two flavors: speculators and dealers.

Speculators predict future price changes using information. Real speculators have something you don’t. Better data, better analysis, better models, or faster access. They’re right more often than wrong.

Harris breaks speculators into two camps. Informed traders trade on fundamental values. They understand what a company is actually worth, and profit when prices catch up to reality. Parasitic traders profit from other traders’ behavior. Front runners trade ahead of big orders they know are coming. Bluffers spread misinformation. Manipulators create fake price action to mislead.

Here’s the uncomfortable truth: informed traders are the only ones who push prices toward correct values. Everyone else, Harris says, adds noise. Economists literally call them “noise traders.”

Dealers make money differently. They stand ready to buy and sell, charging the bid-ask spread for the service. They’re selling liquidity. Market makers handle small trades and flip positions fast. Block facilitators handle big institutional orders and might hold positions for days or weeks.

Futile Traders: The Uncomfortable Category

This is the section that should make every retail trader pause and think.

Futile traders expect to profit but don’t. They lack the skills, the information, or the analytical firepower to compete. The most common type is the pseudo-informed trader. These people think they have valuable information, but they’re trading on old news. Prices already moved. They just don’t realize it.

Then there are victimized traders whose brokers or advisers are not working in their interest. And rogue traders. Harris tells the Nick Leeson story: a trader at Barings Bank who was supposed to do low-risk arbitrage but was making massive unhedged bets on the Nikkei 225. When the Kobe earthquake hit in 1995, his positions blew up so badly they bankrupted a 233-year-old bank. Loss: 1.38 billion dollars. Barings was sold for one pound.

The Zero-Sum Reality

This is the punchline of the whole chapter. Utilitarian traders and futile traders lose money on average to profit-motivated traders. That’s where profits come from. Without the gamblers, the fledglings, and the pseudo-informed traders feeding the machine, the professionals couldn’t make money.

So before you trade, ask yourself: am I the gambler, or am I the speculator? If you can’t clearly articulate why you have an edge, Harris would say you already have your answer.

Previous: Chapter 8: Why People Trade (Part 1)

Next: Chapter 9: Good Markets