Futures Trading as a Game of Luck

A recent interesting article by Ariel Rubinstein entitled “Digital Sodom” (in Hebrew) argues that certain forms of  futures trading (and Internet sites where these forms of trading take place) are essentially gambling activities. 

The issue of “what is gambling” is very intereting. In an earlier post entitled “Chess can be a game of luck” the interesting question regarding “games of luck” and “games of skill” was discussed. It was argued that for a betting game, if, over time, for all players (or even for most players), the expected gains are negative, then we can regard the game as primarily a game of luck. (The claim is that this is a reasonable interpretation of the current law, even if not the only possible interpretation.)

In some more detail, the following definition was examined in the previous post:

A game of luck is a betting game where the short-term outcomes depend on luck and the participants bet in spite of being able to rationally conclude that their expected returns are negative. A betting game is primarily a game of luck if this definition applies to most bets in the game.

When we consider various investments in stock futures, and the Internet sites to which Ariel Rubinstein refers, the first question to ask is how broadly we should understand the term “betting games”. (In some places, laws about gambling specifically exclude stock market activity.) It is not clear if these futures-trading should be considered “betting games” or rather platforms for investment. (Rubinstein’s article made a compelling case that they are essentially platforms for gambling.)  One comment that we can make is that, under usual economic assumptions,  an investement platform that yields, over time, negative revenues for most participants will go out of business… unless, unless the participants’ motivation for playing comes from an irrational belief that they can win or from a love of gambling.

Update: This post is  related to Arrow’s third puzzle from the post on Arrow’s economics. Arrow’s question was: Futures trading in foreign currencies can be explained by agents involved in international trade wanting to reduce their risk. This suggests that the volume of currency futures trading should be below the volume of international trade. Yet currency futures trading is 300 times larger. What can explain this phenomenon?

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9 Responses to Futures Trading as a Game of Luck

  1. Rod Carvalho says:

    I am confused. A few questions:

    1) what do you mean by future tradigng? Can one trade the future??? Or did you mean futures trading? What do you mean by future stock investment? Isn’t investment, by definition, a transfer of money from the present to the future? Did you mean investment in stock futures?

    2) I did not understand if, according to your definition of game of luck, a game where there is stochasticity but where the expected returns are positive is a game of luck or not.

  2. Gil says:

    Dear Rod, oops I meant futures trading, of course. Thanks. (Corrected, I hope.) Yes, if the expected returns are positive I do not consider it a game of luck. Of course, when it comes to gambling in the usual sense of the word the expected returns are always negative.

  3. Rod Carvalho says:

    I don’t want to get very philosophical about this, but I don’t think that futures trading is necessarily gambling. Of course, some people who don’t know what they’re doing, are indeed gambling when they trade futures contracts. But not all. There are economical principles at work in the price formation phenomenon, and I just can not believe that prices fluctuate randomly (lesson: let us not confuse reality with our model of reality). Trading is a game, and if one knew the policies of all the other players in the market at all times, there would be no uncertainty at all. Since no human is omniscient, making crude and unrealistic assumptions may be the one and only way of making the problem at hand tractable. This reminds of your recent post on randomness

    If I remember correctly, Ed Thorp used card-counting when playing Blackjack in order to eliminate the house advantage and have positive expected gains. Technically, he wasn’t gambling, he was investing ;-)

  4. Gil Kalai says:

    Dear Rod, I agree that future tradings is not necessarily gambling and this was not what the article suggested. The article talks specifically anout certain Internet sites that allow the “ordinary person” be involved in futures trading. An example (from the article): If you guess correctly the change in the dollar value tommorow you gain 65% of your investement; If you fail to guess you lose 80% of your investement.

  5. Rod Carvalho says:

    Oh, I see. I think the technical name for such “bets” is event futures. Betting on the direction of the US dollar does not seem to be that different from betting on who will win a sports event, or betting on which candidate will be elected…

    Unfortunately, I cannot read Hebrew. Since the original article is in a JPEG, I could not use Google Translate and, hence, my misinterpretation. Thanks for clarifying!

  6. Gil says:

    Certainly, the issue of randomness is relevant; (Indeed very interesting research on the foundation of probability comes from game-theorists/decision-theorists/economists/philosopheres.)

    This post is also related to Arrow’s third puzzle from the post on Arrow’s economics http://gilkalai.wordpress.com/2008/07/15/arrows-economics-1/.
    The question was: Futures trading in foreign currencies can be explained by agents involved in international trade wanting to reduce their risk. This suggests that the volume of currency futures trading will be below the volume of international trade. Yet currency futures trading is 300 times larger. What can explain this phenomenon?

    So it is interesting if futures trading has some gambling ingredients and also what could be a formal description of “gmbling ingredient” and what could explain gambling behavior of savvy ecomomical agents to the extent it exists.

  7. Gil says:

    Let mention that while Arrow’s puzzle about the volume of futures trading is related, I do not think that the “answer” (or the main asnwer) is necessarily related. I would expect that an answer strictly in the realm of rationality can be found.

  8. I have been trading for in the area of 5 years to date and I’m constantly watching out for practical blogs and writings. This one totally hits a note with me and I’m leaning toward reproducing it on my own site. Would you have any objection?

  9. I THINK, answer SHOULD strictly in the realm of rationality can be found.

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