Re: Similarities between Poker and Investing
 

adios,

I agree. It always comes down to your assessment of fair value relative to that assigned by the market.

The search for favorable odds happens when you calculate your perception of fair value. The process inherently requires estimates such as earnings and growth prospects, reasonable risk premium estimates for discount rates, consideration of competiton for the company's products, consideration of the company's industry, viability of product lines, current market penetration realtive to the industry and the estimate of the penetration possible for the industry itself, . . . . You get the pictue; the list of consideratons is very significant and not limited to this brief outline.

When you assign values to the considerations important to your calculation of fair value, you have, whether acknowledged or not, also assigned probability estimates regarding their likely occurrence. The accuracy of your estimates and the accuracy of your probability assignments form the basis of your ability to search for and find favorable odds.

Re: Similarities between Poker and Investing
 

tek,

In order to contest your position that the stock market is a zero-sum game on an absolute basis, I'm going to extend your example and thereby offer an alternative result.

If you purchased X at 10, sold it at 14, and X then dropped to 12, you will have gained 4 and the purchaser will have lost 2. Your gain is greater than his loss and produces a net positive outcome.

Re: Similarities between Poker and Investing
 

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I use charts. They aren't foolproof, but they work for me.

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Yeah TA is an alternative that I didn't mention. I'm not disparaging TA but I do know that the approach zerosum elaborated on theoretically would work given you can do them well enough.

Not sure about the basis for TA though. In other words as a hypothetical example say that you believe head and shoulders formations gave you an edge. How do you prove that they do?

Re: Similarities between Poker and Investing
 

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Investing is much more difficult than poker - too many variables can affect the outcome of an investment and each investment is diffferent.

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You have to be careful to not confuse "more random" with "more difficult".
I think the biggest similarity between poker and investing is the ability of short-term results to convince a losing player he is a bad one. I think there are many "winning" investors who don't have any edge but just haven't reached the long run yet.

Re: Similarities between Poker and Investing
 

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Quote: "The stock market is not a zero sum game."

On an absolute basis, I agree with your opinion. However, on a risk-adjusted basis, the stock market most certainly is a zero-sum game.

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I think you're confused about either how risk-adjusted returns work or the definition of a zero-sum game. Growth of the underlying company contributing to changes in its intrinsic value is what causes the stock market not to be zero-sum. Risk adjustment is merely a tool for relative pricing of two companies with different volatilities and does nothing to change this fact.

Re: Similarities between Poker and Investing
 

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I believe the stock market is zero sum short or long term.

[...]

Thake options, I write a covered call option. You pay me a premium for the option. The stock goes sideways for two or three weeks. I win your premium and you lose it. Zero sum.

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Replace "stock" with "derivatives" and your statement is correct.

Re: Similarities between Poker and Investing
 

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"The stock market is not a zero sum game."
-- topspin

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On an absolute basis, I agree with your opinion. However, on a risk-adjusted basis, the stock market most certainly is a zero-sum game.
-- zerosum

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I think you're confused about either how risk-adjusted returns work or the definition of a zero-sum game. --topspin

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I can assure you that I am not confused about either.


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Growth of the underlying company contributing to changes in its intrinsic value is what causes the stock market not to be zero-sum. --topspin

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I agree. But this position only speaks to whether the stock market is a zero-sum game based on absolute performance. It is silent on whether the stock market is a zero-sum game based on risk-adjusted performance.


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Risk adjustment is merely a tool for relative pricing of two companies with different volatilities and does nothing to change this fact. --topspin

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Risk adjustment involves more than the consideration of volatility, or at least it should if you want to make better decisions. And risk adjustment is more than a pricing tool. Risk adjustment is more commonly used as a performance evaluation tool.

Risk adjusted performance evaluation normalizes returns across investments relative to the risks realized by the various investments. The process of arbitrage and a competitive, liquid market virtually guarantees that in the long-run the stock market is a zero-sum game on a risk-adjusted basis. Any advantage of return relative to risk is not sustainable long-term, though you may enjoy and exploit it short-term.

Re: Similarities between Poker and Investing
 

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Risk adjustment involves more than the consideration of volatility, or at least it should if you want to make better decisions. And risk adjustment is more than a pricing tool. Risk adjustment is more commonly used as a performance evaluation tool.

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Perhaps you should be more clear about what "risk-adjusted basis" means to you. The terms you're tossing around all have standard meanings in the finance community.

The most common usage of the term "risk-adjusted returns" is for normalizing returns obtained by portfolio managers according to variance. It's based on modern portfolio theory -- in simple terms, riskier investments generally pay off more, and it prevents managers from "goosing" their returns by simply loading up on higher-risk investments. It's a performance measure (to make sure we're handing out grades on a level playing field) and has nothing to do with whether markets are zero-sum.

A game is zero-sum if and only if the total amount of money among all participants is constant -- one person's gain is another's loos. The fact that over the long run the total market cap of all publicly traded companies is continually growing, and thus all equity owners as a whole are becoming wealthier, is simple proof that this is not the case.

Re: Similarities between Poker and Investing
 

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A game is zero-sum if and only if the total amount of money among all participants is constant -- one person's gain is another's loos. The fact that over the long run the total market cap of all publicly traded companies is continually growing, and thus all equity owners as a whole are becoming wealthier, is simple proof that this is not the case.

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My previous posts should leave no doubt that I completely agree with you on this point. It has never been in contention.


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Perhaps you should be more clear about what "risk-adjusted basis" means to you. The terms you're tossing around all have standard meanings in the finance community.

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Only at an elementary level are there standard meanings for "risk-adjusted basis" within the financial community. Even if you want to stay within the comfortable confines of Modern Portfolio Theory or MPT, you encounter profound problems of application. Remember, MPT is a theory. Some even say that when said quickly, MPT sounds like "empty." I rather like that irony.

But, now that I know you have at least passing knowledge of MPT, I can speak to you in terms of alpha, or, as you know, excess return relative to risk accepted. If you understand MPT, you should know that positive alpha exists only in the presence of commensurate negative alpha. Thus, any capture of positive alpha comes at the expense of another market agent suffering commensurate negative alpha. Thus you have a zero-sum game with respect to the stock market as considered on a risk-adjusted basis.

Returning to your contention that there are standard meanings of "risk-adjusted basis" within the financial community, I can only reiterate that such standard meaning is so superficial as to be practically devoid of useful meaning, let alone useful application.

Believe me, I know. I have over eight years' experience conducting research and due diligence on active management equity investors, many of whom are regarded as among the top practitioners in the United States. I have dealt with what "risk-adjusted basis" can mean more times on a daily basis than most people do over the course of their lives.

I have made a note to add a third rule to the two that I try to observe in the interest of friendship and general harmony:

1. Do not argue about politics;
2. Do not argue about religion;
3. Do not argue about the meaning of "risk-adjusted basis."


I hope this post clarifies my thoughts for you. I do not think that we disagree as much as we did not communicate effectively.

Peace be with you.

Re: Similarities between Poker and Investing
 

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positive alpha exists only in the presence of commensurate negative alpha. Thus, any capture of positive alpha comes at the expense of another market agent suffering commensurate negative alpha.

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I see where you're coming from now. Yes, I agree with you here -- excess returns (those due to alpha) can be considered zero-sum. You're right that it looks like we're just differing over terminology: I'd consider zero excess return to be the same as a risk-adjusted return equal to the market return, which is non-zero, while it seems like you're using "risk-adjusted" and "excess" interchangeably.

The reason I originally replied was because of this sentiment:

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Both [poker and investing] are zero sum games. Therefore you capitalize on other peoples errors in both. Thats all either one is about.

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This is patently untrue, and I didn't want anyone (mis)reading your followup post to get the impression that it was. Theoretically everyone can make zero mistakes in their investing, and everyone still makes money. In poker, if no one makes mistakes, all you do is swap dollars back and forth evenly. The poker analogy to the stock market would be someone walking up to your table and tossing an extra couple BB into every pot: the better poker players will win more, but now even if everyone played at the same level you're still all ending up ahead.