Why the stock market in India is not a casino?
This article dives deep into why the stock market is often misunderstood as a casino, using historical data and statistical analysis to debunk this myth.
Why the stock market in India is not a casino?
Posted on 11 Sep 2024
Author: Sayan Sircar
7 mins read
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This article dives deep into why the stock market is often misunderstood as a casino, using historical data and statistical analysis to debunk this myth.
📚 Topics covered:
- Why compare the stock market with a casino?
- Why does the house always win in a casino?
- How does expected return work in the stock market?
- Does this mean that the investor always makes a profit in the stock market?
Why compare the stock market with a casino?
In many households, especially those without experience in stock investments, there are numerous misconceptions regarding the stock market. One of the most popular is:
The stock market is the same as gambling (“juaa” or “satta” or “pasha”).
Many experiences contribute to the formation of this view. One of the main reasons is the bitter experience of the Harshad Mehta scam in 1992, where many investors and traders lost significant amounts of money. Operator-driven stocks or penny stocks are not new. The recent frenzy seen in SME IPOs, with 400x oversubscription, has all the hallmarks of market manipulation.
However, this article is not about that. Here, we will specifically discuss whether the stock market behaves like a casino, based on both historical data and the mechanism of how the overall stock market operates.
We will not discuss individual stocks in this article. An individual stock can be valued, to some extent, through valuation models like DCF. However, a broad market index such as the SENSEX or Nifty 50 is much more predictable and will be used as a proxy for the Stock Market. The reader should note that a market index with more stocks, like the Nifty 500, is even more diversified than the Nifty 50 and will support our conclusions further.
But first, let us understand why casinos always win.
Why does the house always win in a casino?
Casinos, regardless of the type of game offered, make more money than all their customers combined.
One of the ways they achieve this is through the concept of “Payouts vs. True Odds”. For example, in roulette, there are 35 numbers on the wheel from 1 to 35. If you bet $100, you will win $3,500 when your number comes up, meaning the odds are 35-to-1.
🤖 Explainer: What is Roulette?
Roulette is a casino game where players place bets on where a ball will land on a spinning wheel divided into numbered slots. The wheel typically has 37 or 38 slots, depending on the version, with numbers ranging from 1 to 36, and one or two zero slots. Players can bet on individual numbers, groups of numbers, or the colour of the slot, with payouts varying based on the odds of the chosen bet.
However, since the actual wheel has 37 or 38 slots (depending on the country), meaning there will be instances where no player wins, and the Casino (“the house”) takes the entire pot for that round.
Over time, the actual 37-to-1 or 38-to-1 odds shift the balance in favour of the Casino, ensuring that players, on the whole, lose a little bit. Over time, these small losses accumulate, leading to the Casino’s consistent profitability and the players’ overall losses. Using the Expected Value concept, the calculation for Roulette becomes:
Expected Value = Expected Profit + Expected Loss
where Expected Profit = $100 * 35 * (1/37) = $95.59
and
where Expected Loss = -$100 * 1 * (36/37) = -$97.30
so that
Expected Value = $95.59 - $97.30 = -$1.71, which represents a loss for the average player per round.
The stock market does not function in this way, as we will explain below.
How does expected return work in the stock market?
For this analysis, we are using Nifty 50 TRI (Total Return Index = price changes plus reinvested dividends) data from June 1999 to December 2023. We will use a rolling window of one-year holding periods, such as:
- 30 June 1999 to 30 June 2000
- 1 July 1999 to 3 July 2000
This allows us to calculate the following metrics:
| Metric | Value |
|---|---|
| Probability of profit | 75.53% |
| Probability of loss | 24.47% |
| Average profit (1Y) | 25.95% |
| Average loss (1Y) | -13.97% |
Expected Value = Expected Profit + Expected Loss
where Expected Profit = ₹100 * (1 + 0.2595) * (0.7553) = ₹95.13
and
where Expected Loss = ₹100 * (1 - 0.1397) * (0.2447) = ₹21.05
so that
Expected Value = ₹95.13 + ₹21.05 = ₹116.18, which is profitable for the average investor in an average year.
Does this mean that the investor always makes a profit in the stock market?
We are now entering the realm of statistics, generally taught in many states in India either before the Class XII Board exams or a bit later.
Just because the expected value is positive does not mean that returns will always be positive. There is still a more than 24% chance of loss in any given year. This means that even if there is a profitable position in your stock portfolio right now, there is a 24% chance of a loss within the next year.
However, unlike in a casino, the stock market does not make it impossible for the average investor to consistently make a profit, provided they invest in a broad market index fund.
| Held for | Chance of profit | Chance of loss | Average profit | Average loss |
|---|---|---|---|---|
| 1 year | 75.53% | 24.47% | 25.95% | -13.97% |
| 2 years | 82.00% | 18.00% | 21.06% | -7.98% |
| 3 years | 93.39% | 6.61% | 18.32% | -7.44% |
| 4 years | 98.23% | 1.77% | 17.24% | -2.61% |
| 5 years | 99.92% | 0.08% | 17.05% | -0.90% |
| 6 years | 100.00% | 0.00% | 16.58% | 0.00% |
| 7 years | 100.00% | 0.00% | 15.98% | 0.00% |
| 8 years | 100.00% | 0.00% | 15.52% | 0.00% |
| 9 years | 100.00% | 0.00% | 15.05% | 0.00% |
| 10 years | 100.00% | 0.00% | 14.93% | 0.00% |
As the table shows, the longer an investor remains invested, the lower the likelihood of a loss, thereby demonstrating that the stock market does not behave like a casino.
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