Similarities between Poker and Investing

[ozyman]

Looking to teach a friend who works in the investment management field about poker. What lessons/qualities are common for people who excel in both?

Thanks

[mrbaseball]

patience and discipline

[ngkent]

and big cahones

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

[zerosum]

Investing and poker are inherently probability exercises. IMHO, success in either requires recognition, respect and observation of the following guiding principles.

1. Focus on process versus outcome;
2. Constantly search for favorable odds;
3. Understand the role of time.

[topspin]

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

[/ QUOTE ]

The stock market is not a zero sum game.

[zerosum]

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.

To be sure, one can argue about the means by which risk-adjusted returns should be calculated, and one can argue about the amount of time required to properly measure it. However, I think it is quite reasonable to believe that over a sufficient period of time, levels of risk are appropriately rewarded in the stock market, resulting in a zero-sum condition.

As a note, one should not be fooled by the common financial services industry claim that "value" stocks have outperformed "growth" stocks on a risk-adjusted basis as well as an absolute basis. The finacial services industry likes to claim that investing in "value" stocks delivers the elusive "free lunch."

What the industry does not talk about with its clients is that a growing body of research strongly suggest that the so-called "value" stock advantage is illusory, owing to previously applied pricing models that remove from consideration the financial distress risk of "value" stocks.

The industry also does not mention that the "value" indices it uses to make its "free lunch" claim do not account for the survivorship bias built into the returns. To wit, companies that fail or are on the verge of failure are regularly removed from the index by the vendors who construct and compile the index. Thus, a company suffering increasing financial distress to the point of having highly questionable future prospects is highly likely to be removed from the index. The result is that the index does not reflect the significant, if not total, loss of investment one would have suffered by holding the removed stock.

More can be said on this subject, but I think (and hope) that what I have provided is sufficient to give rise to a reconsideration of opinion.

-- ZeroSum

P.S., On a short-term basis, I agree that the stock market is not a zero-sum game, and my investment returns as well as the history of the selection process I use support my opinion to my satisfaction.

With respect to the absence of a zero-sum condition over the short-term, I believe that valuations do not respond with sufficient speed to information that has implications for longer-term prospects, thereby providing profitable opportunities. This condition, in my estimation, owes to the species beneficial feature of our nature that allows the vast majority of people to believe that they are above-average relative to the total population. In poker, those who hold such beliefs but lack the skill advantage are fondly called "fish." Remember, without fish skilled poker players would starve.

[midas]

The only thing that is common in poker and investing is that you need to put in time to learn each skill set. I think its easier for a good investor to be a good poker player but the reverse is not true.

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

[adios]

[ QUOTE ]
2. Constantly search for favorable odds;

[/ QUOTE ]

In general how does one go about determining that they have an edge when buying a stock (or selling short if applicable) and how is that edge measured? Generally speaking, to me the way is to determine the fair value of a stock, look at the value the market has placed on the stock, and use the difference between fair value and the value the market is assigning to the stock as the indicator of whether or not you have an edge (realize that price volatility is a consideration). Is there another way?

[tek]

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

If I buy a stock for 10 and it goes to 12 I make 2. If it thern goes back to 10, the guy who bought it from me loses 2. Of course in between him and I it could fluctuate, but ultimately the trading profit and losses across all the investors who touch the stock will ad up to zero.

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.

[tek]

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