January 5, 2022
Yesterday we shared Kim Iskyan’s fantastic story about how gambling can teach us a thing or two about investing. (If you missed it, click here to read it.)
On the surface, there are a lot of similarities between the stock market and casinos… And Kim breaks it down into six valuable lessons that the game of poker can teach us about smart investing.
To recap, the first rule of successful investing that we can take from smart gambling is:
1. Treat it like a job.
The best investors – amateur or professional – operate like this… 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…
Read on for the other five lessons…
Six Investing Lessons We Can Learn From Poker
2. Find your spot and exploit it.
John doesn’t do roulette, slots, or baccarat. He does video poker – and that’s it. The main reason is that the odds for those other games are far worse… He’d lose more money, more quickly, even if he was the sharpest player in town. And secondly, the statistical purity of video poker plays to John’s math-brain strengths.
Similarly, in investing, if you’re a computer guy, and you live and breathe semiconductor chips, and know your motherboards from your Nvidias to your AMDs, and have been involved in the industry long enough to have a feel for what works and who’s ahead… use that insight to invest in that sector.
It’s fine to dabble in retail, pharmaceutical, or automotive shares, but you won’t be using your natural advantage.
As legendary investor Peter Lynch may have counseled, “Gamble in what you know.” Or not… had Lynch been referring to what people do in casinos, he may have said that. But since he was talking about investing, he actually said, “Invest in what you know.”
3. Be a risk manager first (and second, too).
Before he sits down for a video poker session, John knows exactly how much he can expect to lose within a statistically defined “bad day.” If he has a two standard-deviation (that is, worse than 95% of all sessions) down day, for example, he knows he can lose 10% of his total capital. A catastrophically, once-a-decade bad session could knock off 15% of his capital.
And on the flip side, if he’s having a great day, he knows that it works the other way, too. And that, whether it’s up or down, is in the small minority of all days. Mean reversion – the strongest of all forces in the universe – states that in the end (if he follows the rules to maximize his returns), he’ll lose very close to precisely what the casino’s odds dictate.
In investing – as in gambling – you can only make money if you have money… thus Warren Buffett’s two rules of investing. In investing, stop losses are one important way of managing risk, increasing the odds of being around for another day… and decreasing the odds of a catastrophic loss.
But knowing beforehand how much you can stand to lose – and ensuring that no matter what, you don’t approach that level – is the most important bit of insight of all.
In that way, investing is a far higher-risk proposition than video poker (if not the other diversions in a casino, too), where sticking to certain rules and playing with discipline can limit your losses with mathematical certainty. That’s not the case with a day in the market.
4. Leave your emotions at the door.
When I visited John at the video poker machine (my tolerance for the dizzying electronic card-flipping didn’t extend past the 15-minute mark), the only way I could tell if he was up or down on the day was by asking him – and his usual reply was something like “Doing great! Playing fast and the buttons are responsive.”
His mood and vibe were the same whether he was down a mortgage payment… or up a compact car. There were no whoops of royal-flush joy – or frustrated jack-high pounding of the video poker monitor. He may as well have been watching paint dry.
Why so little emotion? Because it doesn’t matter: John knows the final result, and his objective is to stay within that statistically comfortable, defined space of loss. A big up day will in time be negated by a big down day. The peaks and valleys will eventually cancel each other out.
In the money world, there’s an entire field of study – behavioral finance – dedicated to trying to understand the impact of psychology, cognitive biases, and emotions on investment decisions.
The biggest challenge that most investors face is how to handle losing, or winning, positions – and how to not let their emotions get in the way.
Of course, video poker is a strictly mathematical endeavor – while investing in stocks has a far greater number of variables. But investors in shares could learn a lot from an emotions-free approach to playing video poker.
A new system shows which stocks could soon rise 100% thanks to a Connecticut couple’s catastrophic 401(k) loss.
5. Have patience.
Over the past 100 years, the S&P 500 Index has appreciated (with dividend reinvestment) by an average of 10.8%… and it’s risen in about seven of every 10 years. While there have been some big drawdowns during that time, the best investors have had time on their side – and had the patience to let time perform its magic.
In video poker (and other kinds of gambling as well), it’s also all about patience – though in a different way. If you follow the rules and don’t let your emotions get in the way (two big assumptions, admittedly), the numbers dictate that your luck will change. And more than that, it’s actually not luck: It’s a statistical certainty.
The key is to have sufficient capital to see another day. And that’s as big a challenge in investing as it is in gambling.
6. Save some space for (a little) fun.
Even though he knows the odds too well – kind of like knowing the end of a thriller before you crack the spine – John can still get a kick out of blowing a few bucks on a slot machine.
After the taxing repetition of thousands of games of video poker, a mindless diversion where there’s no place for strategy is a relief. And, even though it’s still in a casino, it can be fun… a long as – like my friend Sam – there’s a clear end line in mind that’s adhered to (in this case, dollars lost).
Similarly… plenty of serious investors have a small pile of fun money. It’s a few percents of their portfolio (at most), or a rounding error, that – if it was vaporized tomorrow – wouldn’t be noticed. That’s the cash for the tiny crypto that the shoeshine guy mentioned, or for Uncle Jed’s can’t-miss hot metaverse small-cap stock.
If it happens to rise in value (or if you happen to actually get the three dollar signs in a row, or a screen full of jokers or Buddhist temples, or whatever on the slot machine), you’re happy… But you don’t expect it, because you’ve already written off the loss in the pursuit of fun.
Gambling isn’t for everyone… And neither is investing.
But one can certainly learn from the other… And just because you’re a gambler, doesn’t mean you can’t be an investor, too.
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Executive Editor, American Consequences
With Editorial Staff
January 5, 2022