How Not To Be A Shit Gambler

Introduction

The reason you’re losing money might have nothing to do with picking the wrong stocks. It’s because the markets has been structurally designed so the average participant WILL lose.

Suppose you have no edge, and are living in a world where trading the market has NO transaction costs (e.g. Robinhood). Let’s say you trade a 100 different stocks every day without an edge. Do you suppose that in the long run, you will breakeven?

Unfortunately, this is not the case. When you buy a stock, you pay the ask price. When you sell, you receive the bid price. The difference between them is the bid-ask spread. So even if you had no transaction costs, you are effectively paying this cost all the time!

Most people think of this spread as a “transaction cost”, the price of doing business, like a commission by another name. It’s not. The spread is a transfer mechanism. And it’s designed to move money from people like you to people who know more than you. Every time you trade, you are losing money to this mechanism.

You can’t avoid it except by trading less.

What Are “Informed Traders”?

Markets have different types of participants. Some people trade because they need to: rebalancing a portfolio, needing cash, putting money to work. These traders don’t claim to know where prices are headed.

Then there are informed traders. An informed trader is someone who has done more homework than everyone else and trades only when they know something the market hasn’t fully priced in. Remember, that the market is a prediction machine where prices are already a first-order dollar-weighted average of everyone’s prediction given their own information. You cannot outperform the market unless you have second-order predictions over where prices are going.

An informed trader can be made many ways. They can analyze the company’s fundamentals and understand them deeply and uncover some missed insight. They can react to news faster than you could read the headline. They can simply build sophisticated models that identify when something is mispriced.

Simply put, an informed trader is someone that is said to “have an edge”. There are a few “flavours” to informed traders. There might be value traders, who spend weeks or months analyzing a company and know when the market price is too high or too low because of some business fundamentals that hasn’t been prized in. There might be arbitrageurs that identify when related instruments are priced inconsistently.

Almost all institutional traders (e.g. prop firms and hedge funds) fancy themselves to be informed traders. Well, that is literally their job! So every flavor of trading you’ve heard of, or seen from prop firms and hedge funds would fall under informed trading.

What unites them is simple: they only trade when they have an edge. Their buying and selling pushes prices toward reality. This is actually valuable. Informed traders make prices reflect what things are actually worth. The problem is that someone has to lose money to them.

And if you’re reading this article, that someone MIGHT be you.

Well, I do hope not!

The Middle Men

Often times, when you are trading, you are not DIRECTLY trading with the informed traders. Unless there’s someone at that exact moment who wants to sell at your price, you’d have to wait. Maybe hours.

Maybe days.

Market makers solve this problem. A market maker is a firm that stands ready to trade with you at any time, buying when you want to sell and selling when you want to buy.

They quote two prices: a bid (what they’ll pay to buy from you) and an ask (what they’ll charge to sell to you). The gap between these is called the bid-ask spread.

The spread is the toll you pay for instant execution. Market makers provide a real service. But there’s more going on in the spread than simple fees.

Understanding The “Spread”

The spread isn’t one cost. It’s two different costs bundled together.

One part covers what market makers spend to run their business: computers, staff, capital to hold inventory, risk that prices move against them. Call this the transaction cost component.

The other part is the adverse selection component. The term comes from insurance. Insurers face “adverse selection” when the people most likely to file claims are most likely to buy policies. In trading, market makers face a similar problem: the people most eager to trade against them are the ones most likely to profit from it. It’s called “adverse” because the selection of who trades against them is systematically unfavorable.

Market makers trade with everyone, informed and uninformed traders alike. But they can’t tell who’s who. Orders are largely anonymous. A market maker sees an order to buy 1,000 shares. They don’t see whether it’s a hedge fund with inside information or a retiree rebalancing.

You might think order size or speed would reveal who’s informed. Not reliably. Informed traders deliberately disguise their orders. They break large positions into small trades, vary their timing, and use algorithms to appear random. The signals are too noisy to be useful.

So market makers are stuck trading blind. When an informed trader buys from them, it’s because the informed trader knows the price is about to go up. The market maker just sold something that’s about to become more valuable. They lose money.

Market makers protect themselves by widening the spread. But how does charging more help if they still lose to informed traders?

A wider spread increases profit on every trade. Most traders are uninformed. So by charging everyone more, the market maker collects extra profit on the majority of trades (the ones against uninformed traders). This extra profit covers the losses they take on the minority of trades (the ones against informed traders).

What this means for you: uninformed traders pay a premium in every trade to cover the losses that market makers take against informed traders. Basically you are, at all times, through market makers, losing to informed traders.

Why Frequent Trading Destroys You

Each individual trade doesn’t feel expensive. The spread might be pennies. BUT, this cost is systematic. You literally lose on every trade, not just most trades.

Trade monthly, and those costs add up to maybe 1-2% per year. Trade daily, and you can lose a large chunk of your capital annually just to transaction costs and adverse selection, even if the market goes nowhere.

Death by a thousand cuts. If you’re uninformed, then every trade is a negative expected value bet. The more hands you play, the more certain your loss becomes.

So... The Practical Recommendation

Trade less. If you lose on every trade, the solution is fewer trades.

This is why passive index investing works. You buy once, hold forever, and incur almost no ongoing transaction costs.

“But don’t I still pay the spread when I buy the index fund?”

Yes. The difference is frequency. When you buy an index fund and hold it for 30 years, you pay the spread once. When you actively trade, you might pay it hundreds of times. A 0.05% spread paid once is negligible. A 0.05% spread paid weekly for 30 years compounds into a massive leak.

For most people: if you don’t have an edge, don’t trade actively. Buy index funds. Hold them. Accept that you’re not going to beat the people who do this professionally.

If You Want To Gamble

Some people are going to trade regardless of advice. For them, the least-bad approach is to trade volatile stocks.

Wait. Volatile stocks have bigger swings. Isn’t that more risk?

Yes, but that’s the point. The spread is a relatively fixed cost, maybe 0.05% to 0.10% for a typical stock. But random price movement varies enormously. A low-volatility utility stock might move 0.5% on a typical day. A high-volatility tech stock might move 3%.

When you trade the utility stock, the spread eats a large chunk of any move. When you trade the volatile stock, the same spread is a much smaller fraction of the typical swing. Random luck has more room to carry you into profit on any single trade.

You would be correct to say that market makers PRICE volatility into their spread. So, your expected value is still negative in both cases. The difference is the range of outcomes. With volatile stocks, some trades will win big enough to feel satisfying. With low-volatility stocks, every trade feels like a slow bleed.

You’re trading expected value for variance. Giving up predictability in exchange for the chance of excitement. It’s gambling with slightly better odds of having fun before you lose OR striking it big with a lottery ticket stock.

If trading is entertainment or you’re looking to gamble, treat it that way. Set aside money you’re prepared to lose. Trade volatile instruments. And trade rarely. Every trade is an admission to the casino.

For those looking to gamble, look for stocks that have EXTREMELY HIGH variance going into an event. For example, a biotech stock that is about to have their treatment approved by the SEC. If you buy the stock shortly before the event, you will experience tremendous volatility that should far outpace your bid ask spread costs!

Remember, if you are uninformed and are looking to gamble (as in, stake it all with the probability of completely going bust), your name of the game is HIGH VOLATILITY, which comes from events that causes LEAPS in prices (repricing events): earnings, m&a, regulatory approvals, legal cases, etc.

What This Means For YOU

How do you know if you’re “informed” or “uninformed”? Can you articulate a specific, testable edge? What information do you have that others don’t?

If you’re trading systematically or trading discretionary with a large number of trades, it’s much easier to tell if you have an edge. You can look at a large sample of historical trades that WOULD have happened if you were trading, and measure if you would have had an edge (accounting for multiple hypothesis testing).

If you’re trading discretionary and number of trades at a couple per year; then you need to be honest with yourself! You may not have enough trades to develop any kind of statistical confidence.

Are you able to identify special situations where you can exercise a second order prediction about prices that the dollar weighted participant does not know?

Are there situations where retail traders might have an edge? In theory, yes. Hyper-local knowledge, extreme patience institutions can’t match, or in ponds that institutions are not going to be fishing in.

In practice, retail typically find strong edges picking up the shit that institutions do not want to deal with (e.g. very thin markets, regulatory risks, etc). These edges are also typically small in capacity (because these are the places institutions DO NOT have interest in)!

Conclusion

The bid-ask spread contains an adverse selection component that systematically transfers money from uninformed traders to informed ones. You cannot outsmart it with order types or timing.

The only defense is to trade less, and if you MUST trade without an edge, choose high-volatility assets where random moves have a chance of exceeding the fixed spread cost.

This means, if you gotta gamble, gamble smartly!