What is the difference between investing, speculating and gambling. Why binary options trading is gambling.
In this episode you’ll learn:
- What are effective theories.
- How do binary options work.
- What is the difference between investing, speculating and gambling.
- How can we identify our strengths.
Using Effective Theories
There is a street in the city of Campeche, Mexico that must rank among the steepest streets in North America, which generally have gradients of 30% or more.
I was at the bottom of the hill on this street and hesitated before deciding to ascend it in our rented 2017 Volkswagen Gol with a manual transmission.
The Gol is a Brazilian made VW with a 1.6 liter engine and 101 horsepower. Our car cost $9,200 new. I know this because in negotiating the rental contract $9,200 is the amount the Budget office in Playa del Carmen took as a deposit on my American Express card after I declined their “optional” insurance coverage since I was covered through my card.
I started the climb and about half way up the hill the RPMs were high enough to shift into second gear. That was a mistake as five seconds later the gradient got steeper and the car could no longer climb with the transmission in second. The VW stopped before I could get it back into first gear.
There we sat. Feet on the brake and clutch, backs pressed against the seats, looking toward the sky.
The first thing I thought of was a video taken in Moab, Utah of an out of control Jeep rolling backwards down a steep incline and then crashing
The second thing I considered was the $9,200 deposit on the car.
Newton’s Laws and Effective Theories
Harvard physicist Lisa Randall in “Edge” wrote, “We all work in terms of effective theories. We find descriptions that match what we actually see, interact with, and measure. The fact that a more fundamental description can underlie what we observe is pretty much irrelevant until we have access to any effects that differentiate that description.”
The Economist recently profiled the scientific work of Andrew Geraci whose laboratory equipment comprises “a glass bead 300 billionths of a meter across, held in a lattice of laser light inside an airless chamber.”
The device is used to “detect forces a few billionths of a trillionths of a newton.”
Geraci works at this extremely small scale with precise measurements because he is searching for “deviations from Newton’s inverse-square law of gravity (that the gravitational force between two objects is inversely proportional to the square of the distance between them).”
Lisa Randall points out that “Newton’s laws work extremely well. They are sufficient to devise the path by which we can send a satellite to the far reaches of the Solar System and to construct a bridge that won’t collapse.” Or to describe what will happen when I release the brake on my VW Gol while resting on a hill if I am unable to shift into gear fast enough.
She goes on, “Yet we know quantum mechanics and relativity are the deeper underlying theories. Newton’s laws are approximations that work at relatively low speeds and for large macroscopic objects. What’s more is that an effective theory tells us precisely its limitations—the conditions and values of parameters for which the theory breaks down. The laws of the effective theory succeed until we reach its limitations when these assumptions are no longer true or our measurements or requirements become increasingly precise.”
Too Much Information
Effective theory is how we approach all areas of our lives. There is too much information to know everything about every topic. Consequently, we focus on what is most relevant in the moment.
Randall writes, “We use a map that has the scale we need. It’s pointless to know all the small streets around you when you’re barreling down a highway.”
Effective Theory In Investing
I often see beginning investors ignore the concept of effective theory. Instead of focusing on investment principles that work at longer-term time scales such as building a diversified portfolio comprised of multiple asset classes implemented through index funds and ETFs, they instead are attracted to the investment equivalent of quantum mechanics.
Binary Options and Retirement Plans
For example, I recently received an email from Jesse who is in his early thirties. He has a daughter who is coming up on her first birthday, and with Jesse’s wife ready to go back to work they have the added expense of daycare to consider.
Jesse says he has a decent job in the auto industry. He wrote, “I have always had this idea in my head that if I could just earn an extra $500 to $1000 a month things would be so much easier. When it comes to investing, I’m not looking to make millions of dollars or anything like that. I am just looking to make a little extra to help offset the everyday expenses we have, and not feel like I am living pay check to pay check. It would be nice to have a small amount of disposable income at the end of every month.
Jesse just started participating in his company’s retirement plan. He contributed $950 in 2016 and his company provided a 50% match. The investment return not counting the match was 13.3% in 2016 according to his retirement statement, which had an ending balance of $1,522.
Jesse wanted to know if that was a decent return. Then he asked for my thoughts on binary options trading.
Jesse suspects it is a scam, but he is still intrigued. He wrote, “From what I have heard, I can invest $200 to $300 and see a half decent return. It’s all automated as well where you set all the trading options and limits and just let it trade for you. It sounds a little too good to be true. But I’m just wondering if it’s worth a shot. If I lose a couple hundred, it’s not going to be the end of the world.”
I won’t get into the intricacies of binary options trading in this piece, other than to express most investors should stay well away from it. It is an extremely complex area and those that make money trading binary options only do so because there is a steady stream of naïve investors on the other side of the trade. In other words, the winners’ investment spoils come at the expense of unsophisticated investors’ losses.
A 60% Return
Jesses made over 60% last year investing with his retirement account including the company match. With his company’s 50% match, his time is better spent advancing his career in the auto industry and increasing the amount of money he can contribute to his retirement plan rather than exploring options trading.
It can be humbling to admit when something is beyond our capabilities. When we have to settle for an effective theory rather than explore the complexities and underlying forces.
I certainly was humbled as I sat on the hill in our rented VW Gol. I made one attempt to get into first gear as the car followed Newton’s laws and started rolling backward. In a panic, I hit the brakes. Then I gradually eased off the brakes, let the car slowly retreat backwards down the hill, and took a different route.