Why good poker players make good investors.

[Jay]

Several guys that I routinely play cards with asked me what it takes to be successful at investing. I starting writing an email to them and it turned into an article and thought I’d share it with 2+2. As a disclaimer, I’m not a financial planner but have enjoyed investing for a long time. The article is why a good poker player can be a good investor and not a “how to” invest article.

There are several reasons why a solid, analytical and experienced poker player makes a great investor. The traits for making money in a poker game are the same traits for making money on the stock market. Here’s why:

Thinking Long Term: Solid poker players understand that poker is “just one long game” and that its been estimated that you’ll win approximately 1 big bet an hour (at a cardroom). The same holds true for investing. It’s wise to invest in solid companies that have a strong financial foundation and good products/services for the long term (about 3 plus years). The goal is to make about 15% a year earnings to double the investment in 5 years. It’s not about day trading (although its debatable that this methodology can work - I do not advise it for true investing purposes) but about buying and holding and reinvesting any dividends. The objective is to hold onto winners and dump the losers so the portfolio is made up of winning stocks.

Taking the Gamble Out of It: Just like playing any two cards at a holdem table can lead to some quick riches on a short rush, more often than not it’s a recipe for total disaster. Making quick day trading decisions is just like playing any two cards. It’s as if you can’t even look at your hole cards and are forced to make a decision to bet, raise or fold. Why take the gamble? Look at your cards, study the stock and make an objective as possible decision and get the best of it. Does the company have a history of solid growth of 15% or more? Are sales growing at the same rate as earnings – if not earnings cannot continue to grow faster than sales forever. Is the company financially stable and can take a pounding when it receives a bad beat? How is management performing? Using stock selection tools there are ways to determine if the stock is currently over valued or under valued. Sometimes there’s a great company out there but it’s overpriced, wait until a dip and pick it up. Just like in poker, poker is about people. The same holds true for companies. Economics is about people when you come right down to it. Supply and demand as was ingrained into the brain in Macro Economics class during college. There will be decisions based solely on subjective input just like if you think the guy will call two bets colds or will fold, there will be times when you’ll face a judgment call on where the company is going.

Getting the Best of It: As with any bet at the poker table the reason a good player bets is because there is an edge that has positive expectation in the long run. It holds true for investing in stocks. Put money into a stock that has positive expectation for the long term. A goal is to pick 4 out of 5 winners in stocks. Just like getting your flopped set cracked by some moron holding 57o and catching a runner-runner straight there will be times when some moron CEO or company makes a dumb move and flushes your good money down the drain. Unlike in poker where it is wise to keep these players in the game, in investing avoiding these companies is the better course. Look at the Enrons and Worldcoms etc. They were great companies and an investor had no way of knowing that these companies would be corrupt so there will be times when the investor sees a positive company and through no control of the investor the company goes bust. That’s why the goal is 4 out of 5. Also when working on a financial portfolio its better to let the winners ride and dump the losers. Just like in poker you should dump your weak hands and play your strong ones. And with your monster hand you’ll want to milk as much money as you can by going all the way to the river. This is the same as holding onto good companies for many years. On another subject related to getting the best of it, as I mentioned earlier there are tools to determine if a stock is over priced or under priced. Buying low and selling high is the name of the game. Although you should consider holding rather than selling unless the price is very overpriced then you should consider only selling some of it.

Understanding Bankroll: This topic is a stretch for a poker analogy and really it covers an area where good poker sense makes good investing sense. In poker it is estimated that about 300 big bets is the amount of money needed to cover fluctuations in limit poker. The stretch is that it’s unwise to take half your bankroll and put it into one game and that holds true to investing. Diversification is the key to success. It’s unwise to take half your investment money and plunk it into one stock. A portfolio should be about 8 to 12 stocks. Again picking about 4 out of 5 winners should be the goal.

Not going on Tilt: Just like getting a hand cracked can put a poker player on tilt, watching the market’s daily reaction to things can really drive an investor on tilt. A good poker player doesn’t let that affect them and they stay the course. For investing, those daily issues of the war, crude oil prices or some incident at a large company that affects the market can quickly create panic and put too much emotion in the decision of buying or selling but by sticking to the game plan and weathering a minor fluctuation your investments will grow. Don’t be quick to jump and overreact as it’s a killer for the long term investor. Also another problem that’s evident in poker and investing is when things go bad the player or investor blames someone else rather then his play or decision. Usually the leak is with the player or investor. Retrace the steps and see why the play or investment didn’t work.

Studying and Experience are keys to Success: And finally to be successful at poker or investing it takes both study and experience. Read those books and understand the concepts of how and why the market works and what makes a good company good. And there’s no better teacher than experience. Sure there will be missteps along the way but that’s part of the game. The true successful players and investor learn from their mistakes and which in turn make them better.

These are traits that both poker players and investors have.

Thanks,
j.

[Paluka]

You put a lot of effort into this, but you could have communicated the same message by saying "smart people are better at stuff than dumb people."

[Dan Mezick]

I add, people that take 100% responsibility for all of their results tend to get the results they intend. They (in)tend to win. In a very obvious way- they take 100% responsibility.

Those who do not take 100% responsibility for all their results also get the results they intended. They (in)tend to lose. Not obviously though...if you get my drift.

[dbirider16]

[ QUOTE ]
You put a lot of effort into this, but you could have communicated the same message by saying "smart people are better at stuff than dumb people."

[/ QUOTE ]
That would be a horrible article. I really enjoyed reading what he wrote. He compared the two different forms of gambling to -prove- a point. Thanks for taking the time to write that jay. It really has helped me get a better view of investing.(something i'm new at)

[DesertCat]

I think much of you wrote is good and true, but allow me to modify a quibble with a few points.

Any good investor could have seen Enron coming, it's cash flow never matched up with reported profits. It was a common target of short sellers for years before it collapsed.

This means, if you really want to invest, you must know how to read the income statement, cash flow statement and balance sheets. And not just know how, you actually have to do it for each of your investments.

Letting winners ride and dumping losers is incorrect. You don't sell stocks because they go down, you sell them when their price is greater than their value, which you discern through fundamental analysis. If you find a bargain, and it goes down, you should want to buy more, up to the limits of your diversification strategy. If a winner's price exceeds it's value, there is no reason to hold it, unless your goal is subpar returns.

You only need four stocks in your portfolio to offer about 80% of the diversification benefits that a sixteen stock portfolio offers. So instead of 8-12 stocks, probably 5-6 are fine. This is because too much diversification hurts performance. Why put money into a twelve best idea, just to be diversified? It won't offer the returns that putting that money into your best ideas will. Small portfolios trade slightly more volatility and risk for (substantially) higher returns.

Of course this assumes you know enough to be able to differentiate between good and bad ideas. If you can't do fundamental analysis, you should stick to index funds and ETFs. Otherwise, if you can read and understand Buffett's and Ben Graham's teaching, your goals should be much higher than 15% annualized returns. This specific knowledge has nothing to do with poker, but any good poker player should be able to understand it with study.

[GeorgeF]

Are there any examples of successfull investors including poker in their bios?

I vaguely remember some traders claiming blackjack card counting experience. Perhaps given the interest in poker today you will see poker in future bios. It seems black jack card counting is more applicable to trading as in the old days counting cards had a more of less guaranteed return which is what traders are looking for.

[lu_hawk]

i do investing for a living and i think that investing and gambling are really the same thing. from my limited experience i would say that all good investors/traders would make good gamblers. but that not all good gamblers would make good investors. in order to be a good investor you need to intuitively know the important concepts in gambling. but it doesn't necessarily translate the other way and i say this because i see a lot of super smart people in the investment field doing and writing about strategies that won't allow them to beat the market, mostly because they are too complicated and cerebral for their own good. warren buffett writes about this a lot.

[Paluka]

Trading is much more like poker/gambling than investing is. People on this board sometimes don't seem to realize that trading and investing are not even remotely the same thing. And within the 2 groups there are many many kinds of trading and investing.

[lu_hawk]

[ QUOTE ]
Trading is much more like poker/gambling than investing is. People on this board sometimes don't seem to realize that trading and investing are not even remotely the same thing. And within the 2 groups there are many many kinds of trading and investing.

[/ QUOTE ]

you are right obviously about the different kinds of invetsing/trading. i do buffett/graham style value investing which would probably be considered much less like gambling than most kinds of investing and trading but i still think that the basic thought processes are pretty much the same in value investing and gambling and i think it has helped me as an investor to have learned poker/gambling.

[OrangeCat]

Nice article.

While I agree that the traits you list are essential to success in poker and investing, I don’t agree with you thesis that good poker players make good investors. This is because there are several other essential traits the two professions do not have in common. For example, people skills like reading players and bluffing are very important in poker but not in investing.

One could write an article similar to yours about why doctors, computer programmers, architects, NASCAR crew chiefs, etc… would make good investors. My point is, the traits you list are to a large extent required for success in just about any profession.

[player24]

[ QUOTE ]
Trading is much more like poker/gambling than investing is. People on this board sometimes don't seem to realize that trading and investing are not even remotely the same thing. And within the 2 groups there are many many kinds of trading and investing.

[/ QUOTE ]

For the most part, the difference relates to turnover and horizon. Investing entails less turnover and longer holding periods. Investing also involves more fundamental analysis whereas traders generally rely, at least in part, on technical analysis.

In any event, both traders and investors depend on patience, discipline and objective odds-based decision making. Most good poker players tend to exhibit those traits.

[Paluka]

[ QUOTE ]
Investing also involves more fundamental analysis whereas traders generally rely, at least in part, on technical analysis.

[/ QUOTE ]

I know a lot of traders, and I don't know any that rely on technical analysis.

[player24]

[ QUOTE ]
[ QUOTE ]
Investing also involves more fundamental analysis whereas traders generally rely, at least in part, on technical analysis.

[/ QUOTE ]

I know a lot of traders, and I don't know any that rely on technical analysis.

[/ QUOTE ]

Your experience is unsual. I have been a trader and investor for 19 years. Managed a $7 billion dollar portfolio for a large (top 5) mutual fund company and now a $1.4 billion portfolio for a hedge fund. (Hedge funds have replaced mutual funds and the sell-side as the place to be...) And my knowledge differs from yours in that respect. Traders are very much oriented towards market timing and they pay very close attention to chart action. The best traders have very good technical analysis skills. Investors tend to rely on fundamental analysis (mainly) and use technical analysis to time their entry/exit.

[KKbluff]

Great comparison! I agree with everything you have to say. Thanks for putting all the time and energy into this article.
A+

[Mike_D]

Jay i do and don't agree with you...I believe traders make good poker players, not investors. I've always used the William O'neil school of thought on selecting stocks which sounds very similar to how you select stocks. I also use alot of candlestick analysis for entry and exit points. A traders is in and out...cuts his loses quickly and rides a rising stock. Using fundamental and ignoring technical will cause you to missing buying/selling opportunities. Only a limit poker player can be ok with losing out in 1 out of 3 trades...if he knows that in the long run he will net a gain.

To really get the same feel as gambling do options. I classify my self as a trader...but I only trade with 10% of my portfolio...the rest are in hedge and index funds. So I guess I'm not that much of a trader. Of my 10%, only a small portion goes into options. Getting back to gambling a limit player knows the odds of making a call or a raise knows the risks involved and what the payback will be...similar to an option trader.

Well that's my two cents I don't consider myself by any means an expert or professional investor...but my portfolio has consistantly out performed the S&P 500, every year. I believe because i keep it simple. I would recommend if someone wants to start buying individual stocks to goto www.investors.com (http://www.investors.com) I swear by it...I can't argue about the returns.

[Paluka]

[ QUOTE ]

Your experience is unsual. I have been a trader and investor for 19 years. Managed a $7 billion dollar portfolio for a large (top 5) mutual fund company and now a $1.4 billion portfolio for a hedge fund. (Hedge funds have replaced mutual funds and the sell-side as the place to be...) And my knowledge differs from yours in that respect. Traders are very much oriented towards market timing and they pay very close attention to chart action. The best traders have very good technical analysis skills. Investors tend to rely on fundamental analysis (mainly) and use technical analysis to time their entry/exit.

[/ QUOTE ]

Most of the traders I know are derivatives traders only, maybe that is the difference. I'd be fired if I showed up to work with a chart of a stock I traded.

[DesertCat]

[ QUOTE ]

Investors tend to rely on fundamental analysis (mainly) and use technical analysis to time their entry/exit.

[/ QUOTE ]

I've never heard of any good investors that use technical analysis for any reason (other than laughs)...

[Glenn]

Yeah, everyone I have talked to/heard from who was highly educated with regards to trading seemed to agree that the only use for technical analysis was to predict the actions of the losing traders who use technical analysis. If you stare at a cloud long enough, it's going to look like something else...our minds look for patterns, and find them, even when they aren't there.

[imported_bingobazza]

[ QUOTE ]
Several guys that I routinely play cards with asked me what it takes to be successful at investing. I starting writing an email to them and it turned into an article and thought I’d share it with 2+2. As a disclaimer, I’m not a financial planner but have enjoyed investing for a long time. The article is why a good poker player can be a good investor and not a “how to” invest article.

There are several reasons why a solid, analytical and experienced poker player makes a great investor. The traits for making money in a poker game are the same traits for making money on the stock market. Here’s why:

Thinking Long Term: Solid poker players understand that poker is “just one long game” and that its been estimated that you’ll win approximately 1 big bet an hour (at a cardroom). The same holds true for investing. It’s wise to invest in solid companies that have a strong financial foundation and good products/services for the long term (about 3 plus years). The goal is to make about 15% a year earnings to double the investment in 5 years. It’s not about day trading (although its debatable that this methodology can work - I do not advise it for true investing purposes) but about buying and holding and reinvesting any dividends. The objective is to hold onto winners and dump the losers so the portfolio is made up of winning stocks.

Taking the Gamble Out of It: Just like playing any two cards at a holdem table can lead to some quick riches on a short rush, more often than not it’s a recipe for total disaster. Making quick day trading decisions is just like playing any two cards. It’s as if you can’t even look at your hole cards and are forced to make a decision to bet, raise or fold. Why take the gamble? Look at your cards, study the stock and make an objective as possible decision and get the best of it. Does the company have a history of solid growth of 15% or more? Are sales growing at the same rate as earnings – if not earnings cannot continue to grow faster than sales forever. Is the company financially stable and can take a pounding when it receives a bad beat? How is management performing? Using stock selection tools there are ways to determine if the stock is currently over valued or under valued. Sometimes there’s a great company out there but it’s overpriced, wait until a dip and pick it up. Just like in poker, poker is about people. The same holds true for companies. Economics is about people when you come right down to it. Supply and demand as was ingrained into the brain in Macro Economics class during college. There will be decisions based solely on subjective input just like if you think the guy will call two bets colds or will fold, there will be times when you’ll face a judgment call on where the company is going.

Getting the Best of It: As with any bet at the poker table the reason a good player bets is because there is an edge that has positive expectation in the long run. It holds true for investing in stocks. Put money into a stock that has positive expectation for the long term. A goal is to pick 4 out of 5 winners in stocks. Just like getting your flopped set cracked by some moron holding 57o and catching a runner-runner straight there will be times when some moron CEO or company makes a dumb move and flushes your good money down the drain. Unlike in poker where it is wise to keep these players in the game, in investing avoiding these companies is the better course. Look at the Enrons and Worldcoms etc. They were great companies and an investor had no way of knowing that these companies would be corrupt so there will be times when the investor sees a positive company and through no control of the investor the company goes bust. That’s why the goal is 4 out of 5. Also when working on a financial portfolio its better to let the winners ride and dump the losers. Just like in poker you should dump your weak hands and play your strong ones. And with your monster hand you’ll want to milk as much money as you can by going all the way to the river. This is the same as holding onto good companies for many years. On another subject related to getting the best of it, as I mentioned earlier there are tools to determine if a stock is over priced or under priced. Buying low and selling high is the name of the game. Although you should consider holding rather than selling unless the price is very overpriced then you should consider only selling some of it.

Understanding Bankroll: This topic is a stretch for a poker analogy and really it covers an area where good poker sense makes good investing sense. In poker it is estimated that about 300 big bets is the amount of money needed to cover fluctuations in limit poker. The stretch is that it’s unwise to take half your bankroll and put it into one game and that holds true to investing. Diversification is the key to success. It’s unwise to take half your investment money and plunk it into one stock. A portfolio should be about 8 to 12 stocks. Again picking about 4 out of 5 winners should be the goal.

Not going on Tilt: Just like getting a hand cracked can put a poker player on tilt, watching the market’s daily reaction to things can really drive an investor on tilt. A good poker player doesn’t let that affect them and they stay the course. For investing, those daily issues of the war, crude oil prices or some incident at a large company that affects the market can quickly create panic and put too much emotion in the decision of buying or selling but by sticking to the game plan and weathering a minor fluctuation your investments will grow. Don’t be quick to jump and overreact as it’s a killer for the long term investor. Also another problem that’s evident in poker and investing is when things go bad the player or investor blames someone else rather then his play or decision. Usually the leak is with the player or investor. Retrace the steps and see why the play or investment didn’t work.

Studying and Experience are keys to Success: And finally to be successful at poker or investing it takes both study and experience. Read those books and understand the concepts of how and why the market works and what makes a good company good. And there’s no better teacher than experience. Sure there will be missteps along the way but that’s part of the game. The true successful players and investor learn from their mistakes and which in turn make them better.

These are traits that both poker players and investors have.

Thanks,
j.

[/ QUOTE ]



Dangerous post - heres some reasons why:

15% is a rubbish return if inflation is 15% or if there are large local currency swings.
A stock doenst become a bad buy or hold because its price goes down, and vice versa. dumping your losers is a loser strategy....despite what stock brokers tell you.

Dont watch the share price, watch the news and the fundamentals. Sales/earnings is very limited as a tool. 3 years is not a long term. Think about 5 year earnings growth rate/pe ratio if you want a quick tool to start the stock selection process.

Financial planners dont usually have a clue about how to pick stocks, they normally concentrate on what funds the 'mother ship' is telling them to push....AVIOD financial planners for everything except financial planning, as well as stock brokers who utter the magic words 'you'll never go broker taking a profit'. Well, they sure as hell wont when you churn your funds every year and earn them juicy commissions.

Most fund managers are short term buyers and so never beat the average of the market.

There is emphiracal evedence that star fund managers do not perform well when they leave their employers where they made their name.

If you want to earn 15%, give your money to Berkshire Hathaway, and forget all about stock picking. They will earn the 15% or more for you over a long period. Tried and tested....to a lesser degree, try the O'higgins system, but this isnt as contrarian as it used to be.

Heres a post about why poker players NECESSARILY dont undertand investing...understand and profit from the difference.

Or just play bingo...

Bingobazza

[Jay]

[ QUOTE ]
Dangerous post - heres some reasons why:

15% is a rubbish return if inflation is 15% or if there are large local currency swings.
A stock doenst become a bad buy or hold because its price goes down, and vice versa. dumping your losers is a loser strategy....despite what stock brokers tell you.

Dont watch the share price, watch the news and the fundamentals. Sales/earnings is very limited as a tool. 3 years is not a long term. Think about 5 year earnings growth rate/pe ratio if you want a quick tool to start the stock selection process.

Financial planners dont usually have a clue about how to pick stocks, they normally concentrate on what funds the 'mother ship' is telling them to push....AVIOD financial planners for everything except financial planning, as well as stock brokers who utter the magic words 'you'll never go broker taking a profit'. Well, they sure as hell wont when you churn your funds every year and earn them juicy commissions.

Most fund managers are short term buyers and so never beat the average of the market.

There is emphiracal evedence that star fund managers do not perform well when they leave their employers where they made their name.

If you want to earn 15%, give your money to Berkshire Hathaway, and forget all about stock picking. They will earn the 15% or more for you over a long period. Tried and tested....to a lesser degree, try the O'higgins system, but this isnt as contrarian as it used to be.

Heres a post about why poker players NECESSARILY dont undertand investing...understand and profit from the difference.

Or just play bingo...

Bingobazza

[/ QUOTE ]

Thanks to everyone for their posts, its always interesting to get different takes on topics such as investing.

Even though the topic is why a good poker player’s traits can be a starting point for good traits for a long term investor there seems to be some areas in the article that must not have conveyed well. And some of that’s the “how to” parts.

1. Let me first say that my statement regarding “dumping losers and letting winners ride” was not intended to imply the stock price but the company itself. That should have been more clear I guess. It is unwise to dump a stock simply because a stock price may have dipped. Here would be some of my guidelines for selling a stock/company in my personal portfolio:

1. Sell because an issue of equal or better quality offers the potential for higher returns.
2. Sell because of an adverse management change.
3. Sell because of declining profits margins or a deteriorating financial structure.
4. Sell because direct or indirect competition is affecting the prosperity of the company.
5. Sell because a company has great dependence on a single product whose cycle is running out.
6. Sell companies that have become cyclical and have low-growth-rate issues because prosperity is about to succumb to recession.
7. Sell some of stock if stock price is greatly overpriced in relation to the companies growth.

My strategy is buy and hold and hold and hold.

So again dumping losers is to dump companies that usually fall into one of these guidelines (except no. 7) and not because a stock price dips. I was talking about long term investing and trying to convey that holding onto companies that may have had a successful run for 5 or 30 years may start deteriorating overall and those should be unloaded to be replaced with a better company. I would not consider the stock price the overall indication of a company on its way out and do not recommend selling based on it. There are many more areas to consider. “Let winners ride” is having companies continue their excellent growth and not to sell them. Buy and hold.

The 15% growth rate is a long term goal based on current inflation rates. If you can maintain significantly stronger growth rates over 10 plus years (at the current average inflation rate), I think a lot of people would love to know the secret.

2. Starting a stock selection requires (for me) at least 5 years of history. Sales, margins and growth are just a few areas to look at but by no means are the only areas to look at. I use many more criteria to find a stock to invest in. It’s just as silly to watch a poker player for 10 hands watch him scoop 7 pots and look at his stack size and say he’s a good player.

3. Concur that financial planners may not understand stocks and picking stocks. I’m not sure why someone would use a financial planner to pick stocks. Or for that matter use a broker to constantly buy and sell stock with large turnover. Or pay loads on a mutual fund. (I didn’t cover this topic in the original article but probably should have.)

Anyway, I probably fell into my own trap and strayed from the original subject but thought I’d try to clear up my thoughts since it appears I didn’t communicate them well. Investing is interesting to me and if the answers were so simple everyone would be rich.

Again, I wanted to say thanks for all the input and comments!

j.

[DesertCat]

[ QUOTE ]

The 15% growth rate is a long term goal based on current inflation rates. If you can maintain significantly stronger growth rates over 10 plus years (at the current average inflation rate), I think a lot of people would love to know the secret.

[/ QUOTE ]
The secret is a small portfolio. A value investor managing less than $10M has many opportunities that professionals can't take advantage of. Fifteen percent should be the low end of your expectation if you really understand value investing, have a smallish portfolio, and work at it.

But if you want to buy mutual or index funds, note that 15% is a very high expectation. Buffet has said the markets long term return is going to be around 7-8% for the next decade or so, given current pe ratios. He first said this a couple years ago, but I don't think much has changed.