10 Lessons Learned From Poker
"Step right up and try your luck...spin the wheel and watch where she lands...everybody's a winner" - sometimes if you listen hard enough you can almost here the Carney coxing unwary investors to step up and try their luck in a game that has been rigged against them. During the last two decades it has been an amazing thing for me to watch as individuals strolled through the doors of the Wall Street casino to try their luck by betting "against the house" for a dream of riches. Just as with anyone who has ever gone to Vegas - you win sometimes; but the "house" wins most of the time.
However, there are always the "professional gamblers" that can do better than the average most of the time. Why? Because they understand "risk" in its various forms. While most amateurs will bet on most hands, take speculative positions where the odds of success are stacked against them or trying to bluff their way through a losing hand - professionals play cold, calculated and unemotional. The professional gambler understands the odds of success of every play and measures his "bets" accordingly. He knows when to be "all in" and when to fold and walk away. Do they succeed all the time - of course not. However, by understanding how to limit losses they survive long enough to come out a winner over time.
There are 10 rules that as an investor you can learn from being a good poker player.
1) You need an edge
As Peter Lynch offers, "Investing without research is like playing stud poker and never looking at the cards." He's absolutely right; it is a clear parallel to how successful poker players operate as people who play cards for a living sit only at tables where the other participants are less sober, more emotional, or less expert. The financial markets are a very large table and it is your job to take advantage of those that are far too emotional to make "sober" decisions, or perhaps just not informed enough to be comfortable accepting them.
2) Develop an expertise in more than one area
The difference between winning occasionally and winning consistently in the financial markets is to be able to adapt to the changing market environments. There is no one investment style that is in favor every single year – which is why those that chase last years performing mutual funds are generally the least successful investors over a 10 and 20 year period. Flexibility is the cornerstone of long term investing success and investors that are unwilling to adapt and change are doomed to extinction – much like the dinosaur. Having a methodology that acts as an operating system where all types of applications can be used will separate you from the weak players and allow you to capitalize on their mistakes.
3) Figure out why people are betting against you.
In essence, if there is one thing that we must always remember, and keep with us daily, is that basically “we know nothing”. Sure, there are some things we can determine, what a company's business is today, maybe even what they are most likely to do in the coming months, even whether the price of its stock is trending higher or lower. But in the grand scheme of things, we don't know much, we are closer to knowing nothing than to knowing everything, so let's just round down and be done with it.
All we really know is what “IS” and all we can really do is create and implement a plan that will deal with what “IS” and protect us from what “Might Be”. Most investors out there can't accept, or even comprehend, the concept of rising earnings and a simultaneously falling stock price, therefore, he has no idea what he doesn't know.
With stocks we have to always remember that there is always someone on the other side of the trade, for every seller there must be a buyer. If there is not, the price will fall until one is found, that's simple supply and demand, but don't assume the person on the other side of the transaction is any more or less informed than you. You have your reasons to buy, they have their reasons to sell, technical analysis is simply a way of recording the overall battle of those willing to sell versus those willing to buy. In poker, you may see a few aces in your hand and think that now is the time to bet it all, but there is often a calculated reason for the guy across the table to match your bets. In poker it is called "checking," in investing it is called "hedging," but both are simply forms of risk management.
Don't assume you are the smartest person at the table, when stocks meet your objectives, be willing to trim, when they begin to break down, begin to become defensive, when your reasons for buying have changed and no longer exist, be willing call it a day and remove your risk.
4) When you have the best of it - make the most of it.
In a game of "Texas Hold'um" when the right hand comes along you can be "all in" and bet it all. The risk with this, of course, is that if another player "calls" you and you lose - your busted. In investing when you have the right set of environmental ingredients in your favor such as an extreme oversold market condition, panic and fear from investors, deep discounts in valuations, etc. those are times to invest more heavily into equities as the "risk" of loss is outweighed by the potential for reward because the "hand" you are holding is a strong one.
The single biggest mistake that investors make today is they continue to be "all in" on every hand regardless of market conditions. "Risk" is only a function of how much money you will lose "when", not "if", you are wrong.
5) It often pays to pass; and 6) Know when to quit and cash in your chips
Kenny Rogers summed this up best: "If you're gonna play the game, boy...You gotta learn to play it right - You've got to know when to hold 'em. Know when to fold 'em. Know when to walk away. Know when to run. You never count your money when you're sittin' at the table. There'll be time enough for countin' when the dealin's done.
Now every gambler knows the secret to survivin' - Is knowin' what to throw away and knowin' what to keep. 'Cause every hand's a winner and every hand's a loser and the best you can hope for is to die in the sleep".
This is the hardest thing for individuals to do. Your portfolio is your "hand". There are times that you have to get rid of bad cards (losing positions) and replace them with hopefully better ones. However, even that may not be enough and there are times that things are just working against you in general and it is time to walk away from the table. This is why using some measure of risk management in your portfolio is critical to long term success. Most people do the opposite of what they should due to emotional biases - the sell when they should buy, the hold onto losing positions hoping they will come back, they double down on losing positions, they sell winning positions too soon and many more mistakes that are almost all entirely driven by emotion rather than logic. Emotional players ALWAYS lose in gambling and investing.
The error that most investors make is that they are playing poker without a hand of cards. Since most investors buy investments, because of what they read in a newspaper, saw on television or heard about on the radio, they have effectively “anted” up for the game. They then basically walk away from the table and begin to hope that the hand they were dealt is the winning hand – this is the basis of the “buy & hold” strategy.
Just like our buy/sell indicator chart above a good investor must develop a risk management philosophy (a sell discipline) and combining that with a set of tools to implement that strategy you can increase your odds of success by removing the emotional biases that drive most investment decisions. Being well disciplined within an investment strategy, just as a professional poker player is disciplined in his game, allows you to act and react successful to a fluid and changing investment landscape. Sell signals, trend changes, pre-determined exit strategies, etc. will give you the chance to fold before losses mount.
7) Know your strengths AND your weaknesses & 8) When you can't focus 100% on the task at hand - take a break.
Two-time World Series of Poker winner Doyle Brunson joked a bit about his book "Super/System," of which he had thrown around two alternative ideas for titles before going with "Super/System". The first of which was "How I made over $1,000,000 Playing Poker," and the second equally accurate idea was, "How I lost over $1,000,000 playing Golf."
The larger point here is that invariably there will be things in life that you are good at, and there will be things out there that you are much better paying someone else to do. Many investors believe that they can manage their money effectively on their own – and they are most likely right – as long as we are in a cyclical or secular bull market. Of course, this idea is equivalent to being the only person seated at a black jack table and the dealers cards are all face up. You might still lose a hand every now and then – but most likely you are going to win.
Me, I would love to be a graphic artist, but until pie charts and analytical tables come into vogue as contemporary art it is unlikely I will be able to fund my retirement by doing it. However, just because my emotions tell me I want to be an artist doesn't mean that I will be good at it. So, for the time being, I will leave it to others that have a penchant for paint. (But if you are interested in a pie chart for your living room let me know…)
Emotion causes us to attach significance to things that have little influence on whether a trade works out or not. Short-term traders often rely on a narrow statistical advantage in their methodology that allows them to be profitable over time. Emotions will deter this and over time have caused countless trading debacles, some of which ended in large hedge funds causing near-currency collapses. And that's only looking at the Nobel Laureates.
Tom Dorsey wrote; “Consider this, if someone offered to flip a coin for you and offers you a better payout on heads than tails, the only logical bet would be on heads. So there is only one decision, logically, but emotion may cause you to remember that the last time you took heads was in the 1958 NFL Championship game at Yankee stadium. You were with the Giants and called for heads in the overtime session, losing not only the coin toss, but also the game, eventually, to Johnny Unitas and the Colts.
That decision may be one you will remember for the rest of your life, but it isn't one that will have any impact on the bet at hand. Nonetheless, we are all human and all susceptible to these types of thoughts, just some more than others.”
That is why there are so few successful poker players in the world but so many people willing to fund the Las Vegas strip. Most people are more than willing to take a risk with their money in the hopes of hitting the jack pot, the dream of being rich has been embedded in us since birth, however, very few investors have any idea of the “possibilities” of success versus the overwhelming “probabilities” of failure. Therefore, as in my case, I can’t paint, therefore, I understand that there is a huge probability that I will not be successful as an artist versus the slim hope (possibility) that people will flock to my door wanting 8 ½ X 11 framed pie charts. (Readily available at our website)
If you are not successful at managing your money over the long term you will wind up losing money – 80% of all investors do. It is better to be honest with yourself and begin an approach to increase your probabilities of success. There are literally thousands of articles, research reports, contradicting opinions, radio programs, television shows, etc. – how are you supposed to determine what’s important and what’s not – that is the difference between a professional poker player and every one else. In a blink of an eye the professional can read the table and make a determination as to whether it’s time to “hold’em” or “fold’em”.
9) Be patient
Patience is hard. Most investors want immediate gratification when they make an investment. However, real investments can take years to produce their real results, sometimes, even decades. More importantly, just like in playing poker, you are not going to win every hand and there are going to be times that nothing seems to be "going your way".
No investment discipline works ALL of the time. However, it is sticking with your discipline and remaining patient, provided it is a sound discipline to start with, that will ultimately lead to long term success. I remember in the late 1990's the media equated investing with Warren Buffet to driving "Dad's old Pontiac" since Warren didn't embrace new technology. He didn't embrace new technology because he didn't understand and valuations on those companies made no sense to him. He stuck with his discipline even though he was grossly under performing the market. Eventually - his discipline paid off because it was a sound investment discipline to begin with and he was patient to allow it to work for him over time.
10) Examine your motivation for playing.
Why are you trying to manage your own money? Is it that you love doing it? Is it the “thrill of the chase and the agony of defeat” syndrome? Or, did you just think that is what you are supposed to do? It's a fair question, you've probably been asked it before, you've probably even got a well thought out answer. However, the real question that you need to ask yourself is “Am I successful at managing the future of my family and my retirement?”
"To a Real Player, gambling is only a certain part of what happens at casinos or at the track. Gamblers (or average investors) are people who either don't know what they are doing, or like to bet against the odds. Good poker players (and good investment advisors), like good horse players, search for value. They leverage advantage. They look for small truths and they hope other people (competitors) don't notice. They manage risk, and expect rewards for playing well. They like the sport. They like knowing. Call these people craftsmen. Don't call them gamblers."