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.