[Welcome to the third installment of our gambling/investing series.  Just in case you missed them, feel free to read Part One and Part Two.]

We’ve already determined that gambling and investing are remarkably similar from a definitional point of view.  It’s easy to see why investing would fall under the definitional umbrella of gambling.

But this isn’t just a word game.  The two concepts share a few other similarities, bringing the arguments of those who claim a distinction into question.  Let’s look at a few of the traits the two practices share in common.

Risk/Reward Assessment. Both gambling and investing require the participant to make probability assessments and to weight the likelihood of different possible occurrences in light of potential rewards (or losses).  James G. Lainas wrote an interesting Honor’s thesis on gambling and investing, “An Inescapable Truth:  Finance is Gambling”  in which he observes this similarity and others in detail.

Consider a blackjack player who is holding a “hard sixteen” (a ten/face card and a six) against a dealer who is showing a seven.  An educated player recognizes that the odds are stacked against her and that taking another card is a marginally better decision than staying on sixteen.  A player who has been closely observing the cards dealt and who has an idea of its remaining composition (i.e. a card reader) may shift the play to staying on sixteen based on the information he has.

In either case, the decision isn’t random guesswork.  It involves an assessment of probable outcomes and potential rewards and risks.  It’s not much different than the investor who analyzes conditions in order to make a stay/sell decision on a stock in her portfolio.

Don’t get me wrong, they aren’t identical situations and the probabilities involved may be radically different.  The underlying thinking, however, is similar.

Knowledge is Power.  Both gambling and investment tend to treat well-informed participants more generously than ignorant ones.  It’s possible to make money in the stock market by throwing a dart at the quotes in the morning paper, but you’re more likely to experience success if you carefully evaluate potential purchases and companies.

The same holds true in many gambling situations.  Consider sports betting.  Much like stock purchasing, there are no sure things.  However, the player who carefully analyzes situations, match-ups, injuries and past performance will have a leg up on the person who chooses a winner based on the color of jersey that team wears.  In the short run, the “I like red jerseys” bettor might get lucky.  In the long run, the informed gambler is likely to do better.

This is often overlooked by those who draw a sharp contrast between wagering and investing.  They like to make that argument by using examples of betting that are more divorced from investing than others.  It’s easy to find a distinction between the two when you’re looking at “betting on a coin flip” vs. choosing a mutual fund.

The line is blurred to the point of erasure, however, when your comparing a stock buyer to a serious horse handicapper.

Systems and Psychology. Gamblers are notorious for their “systems”.  The only people more likely to believe in foolproof ways to win?  Investors.

Members of both groups, occasionally, stumble upon good ways to maximize the chance of  “winning”.  The problem?  Both groups have members who are prone to deviate from their rational planning in the face of unexpected results or fluctuations.

Investment experts will remind you to invest with your head, not your heart.  Serious gamblers will tell you to bet with your head, not your heart.  The psychology of the two endeavors and its impact on results is very similar.

We’ll undoubtedly uncover a few more similarities tomorrow when we start directly addressing some of the arguments that claim gambling and investment are dissimilar.