January 4, 2022
“The stock market is a casino”…
Those words have been uttered by lots of people who understand neither the stock market nor casinos… And (as I’ll get to below) they also don’t get risk management, or how to keep their emotions in check, or the value of, you know, work.
On the surface, though, there are a lot of similarities between the stock market and casinos…
Stocks and gambling involve risking – and losing – money. With both, it often feels like “they” – in stocks, speed-of-light algorithms, market makers, and insiders… or, in casinos, “the house” and pit bosses – have rigged the system against us normal folk. And luck – ostensibly – plays an outsized role in determining how much we win or, more often, lose.
But it’s easy to tar markets with the dark brush of casinos – as Massachusetts Senator Elizabeth Warren did last January on CNBC when she called for greater regulation of the stock market…
The whole point of having a stock market is so that people across this country around the world can invest in businesses… Instead, what has happened is it’s turned into a casino so that market manipulators come in and they drive markets up or down and make a profit on it… the stock market… has become the giant casino and playground for the billionaires…
What’s more, the dopamine rush – the euphoric brain chemical – of a market win or a poker win is nearly identical. And the ease with which the Reddit-residing meme-stock kamikaze capital transitioned to stock speculating from sports betting points to casinos and stocks being twins separated at birth.
But if you’re the stock market equivalent of a 3-a.m.-push-your-chips-to-the-center-of-the-table and stagger-up-to-your-room gambler (that is, you’re an undereducated investor who takes risks blindly)… then you’ll certainly lose money at the casino.
You can claim that it’s all rigged against you – though, in reality, you deserve to lose every Ben Franklin in your wallet. (And Sen. Warren is on the other line, asking you about the size of your contribution to her next campaign.)
But smart gambling – that is, strategic, mathematical, systematic, and analytical – has a lot in common with successful investing. And through that prism, “the market is like a casino” isn’t a damning indictment… it’s more of a compliment and an invitation.
The Smart Gambler
My friend John is a former chess expert, a math whiz, and a philosophy junkie. He eats logic puzzles for breakfast, dissects your ramshackle arguments for lunch, and gorges on statistical riddles for dinner.
And John’s a gambler… We met up last month at a to-remain-unnamed casino. (“I don’t want them to cut any potentially profitable opportunities,” he explained to me.) After a brief survey of the terrain, John installed himself at the video poker machine that has the best odds. (The odds are determined by the payouts posted on the machine. Since video poker machines randomly deal a standard, 52-card deck, you just need to know where to look. The difficult part is knowing what they mean.)
John plays a video version of five-card draw, which is one of the more straightforward poker games – you’re (virtually) dealt five cards, and can trade in up to five cards.
You play against the machine, so there’s no card counting, no bluffing, no flirting with the dealer, and no struggling to read the poker face of your opponent through his Texas trooper mirror sunglasses. Played properly, it’s 24 karat probability.
Doing What Might Not Feel Right
That means that for every possible hand, there’s an optimal play to maximize potential return – that is, when to hold two cards of the same suit or swap them. And the optimal play isn’t always intuitive.
For example, most video poker games have a very large payout for a royal flush (which is a ten-jack-queen-king-ace of the same suit… for a primer on the hierarchy of poker hands, see here.)
So it’s mathematically correct to do things like hold an ace-queen-ten of (say) hearts, and discard a ten of a different suit (even if holding it would give you a pair). That’s because of the 1,081 possible combinations of the two fresh cards to be dealt, one of them is a jack and king of hearts – which is a monster win.
Of course, along the way, those two other cards (the discarded ten and the other fifth card in the hand) could result in a straight (five cards in order, different suits) or a flush (five cards of the same suit). Those are good hands and payouts. And in the long run – millions of hands, that is – tossing the pair is the most profitable play. To John, there’s no decision involved… it’s a statistical fact.
John has internalized these rules and practiced them in simulated games until they come naturally. He plays upward of 10,000 practice hands before any trip (there’s an app for that), so that deciding whether to hold or toss the eight of hearts when he’s dealt an ace, king, ten and eight of hearts, along with a jack of diamonds (something that to amateur poker players would feel like putting hot sauce on your ice cream) is as automatic and natural as flipping the turn signal up to turn right while driving.
And what about betting with your gut… getting in a groove… going on a hot streak? There’s no such thing in statistics. John would sooner toss cash off his balcony (“at least then I would get the fun of seeing people go nuts trying to pick it up”) than ignore the math in his head.
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Did He Win? No… and Yes
During our visit, John played 1,000 hands of $5 video poker each hour for a total of $25,000 of “action” per hour (that is, the total sum gambled). Each of these hands required a unique math-driven decision – about 17 decisions per minute. In a single morning’s session, he targeted generating a throughput – that is, total sum gambled – of around $100,000.
And did he win? He had up days… and down days. Overall, for the seven-day trip, he was down around $1,000 on a total gambled sum of $700,000. For the year, he’s down about $4,000 on his $2.5 million of “action.”
John’s a strictly by-the-numbers gambler. He follows the rules. So why is he down?
Well… the cliché is true: In the end, the house always wins. Even playing a game with the best odds, applying strict math logic, the house has a 0.3% edge. (That compares to the house edge of 5% to 10% for most slot machines, and 5.3% for American roulette.) What that means is for every dollar of “action,” John would expect to lose 0.3 cents – compared to up to a dime at a slot machine, or a nickel at the roulette table.
Those are cruel odds… but casinos are a business, not a charity. If you walk out a winner, you’re a temporary statistical anomaly. And if you go back in, you should expect to revert to the mean – and lose.
But the total-return calculation – beyond any direct losses at the video poker machine – for some people is a different story. For example, John has palladium-platinum-on-steroids hyper-diamond-sapphire club status at his casino (remember that big throughput number?).
So when he’s at the property, his flight, room, meals, limo trip to and from the airport, and pretty much everything else is free… and he’s treated like Saudi royalty. The casino gives him free money to play more, and gifts him VIP passes to world-class shows, and he’s had dinner at more Michelin-starred restaurants than a Paris food critic – just by playing the game.
Added up, the perks more than compensate – by a country mile – for John’s losses at the video poker machine. For the price of a few hours of relatively low-risk gambling each day he’s there, John gets a great vacation – almost for free.
And is it fun? Few people in the windowless, smoky caverns that are casinos ever look like they’re having a good time (except if they’re doing the 3-a.m.-chips-to-the-center thing… in which case, the fun is drowned out by morning).
And that’s the first rule of successful investing that we can take from smart gambling…
1. Treat it like a job.
My friend Sam – also on the trip – isn’t a gambler. He’s like most casino patrons. “I’m ready to lose $500, and then I’m done,” he told me the first day when we wandered into the clockless space of the casino.
Sam played some slots, sat down at a video poker machine a few times, and tried his hand at a few other games. He had no system or approach and didn’t calculate the odds of anything. He won sometimes, thanks to blind luck, but – in line with statistical inevitability – mostly lost. And once he blew through his $500, he was done. It was fun – in a casino-fun kind of way, at least.
John, though, doesn’t enjoy gambling. And preparing for it by drilling himself on the odds isn’t much fun. He approaches his hours staring at a video poker machine with the kind of grim determination that most of us associate with a long-deferred visit to the dentist. To John, gambling is a means to an end – the perks that justify the whole adventure.
In other words… it’s like a job.
And this is similar to how the best investors – amateur or professional – operate: They do the hard work through research and due diligence, they’re focused and controlled, and they know their objective.
If you do invest any other way, it’s just punting for fun, like the $500-then-I’m-done gambler… And if you wind up making money in stocks that way, it’s luck. And luck will eventually turn…
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Executive Editor, American Consequences
With Editorial Staff
January 4, 2022