Poker and Investing

Early in January of 2010, Senior Editor Bob Frick of Kiplinger’s Personal Finance published an article linking poker skills to success in investing. Putting aside the obvious analogy of the Stock Market being another form of gambling, Frick pinpointed the one hallmark of professional card play that translates directly into investment savvy—controlling one’s emotions.

Moods Make Mistakes

The Kiplinger penslinger quoted World Series of Poker Champion Daniel Negreanu in making his point: “Having emotional stability and emotional control is key to both investing and poker.”

Andrew Lo, Director of the Massachusetts Institute of Technology Laboratory for Financial Engineering, agreed. Apparently the psychological issues that influence both investing and gambling decisions are not just similar; according to Lo, they are “identical.”

Greed is certainly one factor apparent in both realms. Others parallels include overconfidence, regret and (everyone’s least favorite) holding on to losers. Also, just as poor poker players start counting their winnings before the hand is done, so do unskilled investors begin planning how to reinvest funds not yet earned.

Prudential Securities Portfolio Manager Aaron Brown is the author of “The Poker Face of Wall Street” (Wiley, 2006). He believes that investors can overcome many of the emotional errors that plague their decisions by improving their poker talents. “People tell me playing poker is risky,” says Brown. “Investing for a financial lifetime without playing poker is risky. I’d much rather make these mistakes at the table.”

Three Quick Examples

In poker, novices typically have no idea how many chips are in their stacks or what the pot odds are. By contrast, pros always keep a running count of how much they’ve got available, what they’ve bet and the amount they stand to gain. Assessments of this sort apply directly to investing. Investors must always be asking themselves, “How much am I in for? What’s the risk? What’s the likely return?”

As the immortal Kenny Rogers’ song tells it, “You’ve got to know when to fold ‘em.” Top-ranked poker pros toss in their hands as much as 90% of the time. They avoid getting too attached to their cards. Smart investors need to be able to steer clear of unwarranted risks and walk away from bad investments. Emotional control means always having the ability to cut losses and run.

Of course, there’s no shame in losing; setbacks are part of the game and to be expected. Poker players quickly learn not to “chase the dragon,” trying to win back losses when short on cash. Investors need to develop the same attitude—“Win some, lose some.” It’s how investments perform over the long-term that counts. Poker can help investors see the benefits of taking the long view.

To Boldly Go….

Neither poker nor investing is for the faint of heart. There will always be times when a bold move is required. In fact, as poker players know all too well, in many instances the only appropriate action is to go “all in” and risk everything.

Here, too, emotions can cloud judgment. Fear of failure may inhibit taking the leap. But a player who has experienced many such occasions begins to appreciate the opportunities when they occur. Risks must be taken in order to win big. That may not mean taking out a second mortgage to speculate in gold futures, but it could mean pooling all of one’s investments in one well calculated trade, and that takes a form of cool, calm decision-making more easily honed at the poker table than on the trading floor.

One other investment mistake that poker can help overcome is to stop seeing patterns where none actually exist. It’s not by error that mutual-fund advertising always warns “past performance is no indication of future returns.” Last year’s returns say less about a fund than such fundamentals as fund size, fees, turnover, manager tenure, etc.

Good poker players trust the odds, not hunches. They don’t raise on a four-flush because “spades seem to be following hearts” or some other implied karmic process. They don’t trust in luck, hope or intuition when solid math is available, and neither should investors.

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