Friday, October 2, 2009

SPECULATION VERSUS GAMBLING




One knows that gambling (maysir) is prohibited in Islam – but what about speculation? Are these two the same or are they different? I’ve asked a few of my Professors and they have different opinions on the subject.


According to legendary investor, Benjamin Graham, "The distinction between investment and speculation in common stocks has always been a useful one and its disappearance is a cause for concern. We have often said that Wall Street as an institution would be well advised to reinstate this distinction and to emphasize it in all dealings with the public. Otherwise the stock exchanges may someday be blamed for heavy speculative losses, which those who suffered them had not been properly warned against.".


Martin Fridson divided the definitions of speculation into four categories - the definitions either implied the use of or involved (1) price changes, (2) quick profits, (3) high risk, or (4) some combination all three elements. Fridson was quick to point out that definitions can be dangerous and makes two points in attempting to prevent misunderstandings. "First, there is no inherent contradiction in acknowledging that a deviation from the market portfolio in pursuit of capital gains is, by definition, speculation, while rejecting the claim that securities markets are perfectly efficient . . . At any given time, however, judging which securities are misvalued involves a certain amount of conjecture. 'Speculation' is therefore a fair term for attempts to exploit pricing anomalies. Again, it should be regarded as a description, rather than a pejorative appellation. Second, a genuinely usable definition of speculation must take into account that many portfolio managers concentrate within subsets of the universe of assets."


Bodie, Kane & Marcus (on their text book, Investments) argued that the primary difference between speculation and gambling is "commensurate gain." They reason that "a gamble is the assumption of risk for no purpose but enjoyment of the risk itself, whereas speculation is undertaken in spite of the risk involved because one perceives a favourable risk-return trade-off. To turn a gamble into a speculative prospect requires an adequate risk premium for compensation to risk-averse investors for the risks that they bear. Hence risk aversion and speculation are not inconsistent."


Regardless of how you define the terms, it is likely to be a worthwhile activity to estimate your expected returns on both an absolute basis as well as relative to an appropriate benchmark. And if you find yourself enjoying the activity of investing or if you find yourself addicted to the speed and excitement of the trading game, perhaps you should seriously consider whether you've crossed the line between investing and speculation, or worse yet, maybe you are really gambling with your money.


From an Islamic viewpoint, a good article has been written by Rafic Yunus Al-Masri titled “Speculation between Proponents and Opponents”, which was published in the Journal of Islamic Econ., Vol. 20 No. 1 (year 2007), pp: 43-52 where the author summarized the two viewpoints of speculation versus gambling and the exceprts are reproduced here:


The proponents of speculation differentiate between speculation and gambling on the basis that speculation depends upon information, experience and study unlike gambling that leans merely on fortune and coincidence. Yet, some believe that there are two types of speculation:

- The first type depends upon experience. This type is few in number (speculationof big professionals).

- The second type which is more popular depends upon fortune (speculation of small amateurs).

Despite the differences between them, both types are considered speculation. Likewise, modern gambling could also depend upon information, experience and study.

The proponents of speculation believe that the gambler himself creates risks, while the speculator only transfers risks as he undertakes existing ones. On the other hand, the opponents of speculation believe that there is no difference between speculation and gambling, but rather it is a new version of it. They argue that in speculation as well as in gambling a few people gain huge and rapid fortunes while the majority loses and whatever is gained by the minority comes at the expense of the majority. In addition, the chances of the minority’s making a profit is very small, very close to their chances of winning the lottery. Accordingly, they are more liable to loss in both cases. On the other hand, big speculators' profits are huge and guaranteed at the expense of small speculators who are being exploited in the stock market to act as its fuel and victims at the same time. “


What interests me most about the article is when the author wrote in one of the conclusions, “Speculation, gambling and monopoly are the characteristics of Capitalism, even if capitalism pretends to stand against these practices. Capitalism either calls things with other names or mentions something theoretically and violates it in practice. It does not abide by religion or ethics unless they serve the tycoons even if this leads to the small investors’ destruction. They want to impose upon us their system so that we lose the best we have and to receive the worst of what they have. This way they guarantee we stay behind in what they are already behind in.”


Well, that is something to think/discuss about…..


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