“Investing is not a game where the guy with the 160 IQ beats the guy with the 130 IQ. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.” – Warren Buffett

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I have followed with great interest some of the material that has been floating around the news feeds and blogosphere in recent times about who should and should not (and who can and cannot) invest or have valid economic and investment viewpoints.

The first of the articles has been written by the James Montier of GMO, who has a formidable reputation as an investment practitioner who often writes expertly on the areas of value investing and investor psychology.

Mr. Montier’s article – “Barbie Does Economics” – takes issue with a paper by Kartik Athreya of the Federal Reserve entitled “Economics is Hard. Don’t let Bloggers tell you otherwise”. Athreya claims that if one doesn’t have a PhD then one (a) shouldn’t be taken seriously in any economic debate, and (b) doesn’t have the ability to make a meaningful contribution to economics or any discussion of economics. Needless to say Mr. Montier counters Athreya’s proposal quite effectively, starting of with the simple question regarding how many PhD-equipped economists predicted the recent economic crisis (please do read the rest of the article).

The second of the articles was posted by Mark Cuban on his BlogMaverick site and is entitled “The Stock Market is still for Suckers and why you should put your money in the bank”. In it Mr. Cuban claims that the “average investor” who toils away for a short period of time per week doesn’t have much chance of competing against the professional investors who watch the markets 24-7.

Since Mr. Montier hasn’t fixed his baleful stare on Mr. Cuban I will endeavour to provide an opposing viewpoint. I must preface all my comments by stating that Mr. Cuban is a very successful entrepreneur and investor. In addition, as the promoter of Texas Holdem Investing I’m a fan of Mr. Cuban since in the past he proposed setting up a hedge fund that would make money by “gambling” based in part on the similarities between the two fields. But that does not give Mr. Cuban the right to tell all the “average investors” that they are not equipped to deploy their own money in the stock market.

And now onto my own perspective, which hopefully you find valid even though I do not possess a PhD (I am a “professional” investor with some background in stocks, although some people would say this is grounds for dismissing my opinion). Firstly, it is certain the Mr. Cuban has great skill in identifying suckers since he sold his company Broadcast.com to Yahoo in 1999 for $5.9 billion (of Yahoo stock admittedly) on the basis of 1999Q2 revenues of $13.5 million (Yahoo’s market cap now is approx. $18.6 billion). But given the rest of his investing history (often in private investments) it is difficult to ascertain Mr. Cuban’s qualifications to advise on stock market investing, compared to say Warren Buffett (who Mr. Cuban’s quotes and who I quote in this article, but for different reasons). It is also tricky to analyse Mr. Cuban’s perspective as to why it is currently a bad time to invest in stocks since the main parts of the article are both anecdotal and theoretical and does not refer to any data or periods of stock markets history. When making such a proposal as Mr. Cuban does in the piece, I would prefer to see analysis along the lines of the work in Vitaliy Katsenelson’s book on Active Value Investing about long term stock market trends (you can see a PDF of the introduction here). This type of research has been quoted extensively by some major hedge fund managers recently such as Whitney Tilson of T2. And at the end of Mr. Cuban’s article, despite stating that the stock market is for suckers, he proposes that you should only forgo investing your “new money” into the market. But if the stock market is for suckers should an “average investor” have any money in the market?

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And so now onto my own addition to this discussion, which is the concept that all people should have the ability to learn the fundamentals of investing and then be able to apply this information to manage their own money to some extent. And no person or institution has the right to tell people what limitations they have in terms of investing ability. As an aside the genesis of this blog post is one of the first sections of the free ebook – “Texas Holdem Investing – An Introduction” – which will be released soon. (*)

The investment education literature available often seems to fall into two categories in terms of its view on peoples’ investing ability and therefore the best way to provide investment training.

1. Most people do not have the required ability to invest in a way that can “beat the market”. Therefore, people should practise an “allegedly simple” form of investing which is selecting asset classes and allocating capital to so-called index funds for the relevant asset classes which will replicate market returns.
2. Most people do have the required ability to invest and achieve better returns in the market. Therefore, people should learn how to “pick stocks (or whatever other type of asset)” to beat the market.

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It is both wrong and arrogant to state that no-one should invest (or “only the professionals”) because it is impossible to “beat the market”. Equally, it is both wrong, and dangerous to state that most people can definitely develop to a high level the required skills to achieve better returns than the market.

The commentators who make statements about what type of investing is suitable for “people” may be speaking to the benefit of their own agendas, and surprisingly so in some cases.

• John Bogle denounces stock selection and then recommends that you invest in Vanguard index funds (which involves asset allocation “selection” decisions).
• Warren Buffett preaches the gospel of fundamental value based investing and himself concentrates his investments in a small number of assets and then says that most people should invest in diversified index funds.
• William Bernstein talks about the benefits of asset allocation and then mentions that value investing as developed by Benjamin Graham does work.

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Everyone is likely to have some sort of capability to invest their financial capital well given the correct education and training. Charlie Munger once described the requirements well in a commencement speech to the USC Business School in 1994.

To demonstrate this point, and answer the question “who can invest”, it is interesting to analyse the diverse backgrounds of some of the great investors. There is no cookie-cutter template in terms of background, education, or career that these

• Ken Griffin (Citadel) is the Michael Dell of the hedge fund world having started out trading convertible bonds in his Harvard dorm room.
• Steve Cohen (SAC Capital) studied economics at Wharton but apparently learned many of the key concepts of risk taking with money while playing poker in between lectures.
• Jim Simons (Renaissance Technologies) was a mathematics professor at Stony Brook University.
• Bill Gross (PIMCO) initially joined the Navy and then played blackjack professionally before moving into fixed income management.
• David Einhorn (Greenlight) majored in government studies in college, and then spent two miserable years in investment banking before founding his hedge fund with less than $1 million.

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The “professionals” in the investment world certainly don’t have a monopoly on being right and providing (advice on how to achieve) better investment returns than either “the market” or “the average investor”. Numerous pieces of research have shown that the “average professional”, often represented by mutual fund managers, produces investment returns below market index return levels.

But what about “above average professionals”? Even they suffer from restrictions and issues that come with the task of managing large sums of money. Joel Greenblatt (no investing slouch himself) does an excellent job of demonstrating this point in the introduction to his book “You Can Be A Stock Market Genius” where he describes how difficult it is to invest a large sum e.g. $2.5 billion, in a focused portfolio of liquid stocks, amongst other problems.

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Competent investing of your own funds can be an excellent way of increasing your net worth. Although investing well cannot guarantee untold riches you shouldn’t deny yourself the chance to learn effective investing because of the conventional wisdom of the fund industry and other experts which states that asset managers, Wall Street and The City (or the “professionals”) know what is best for your money. It is clear that they don’t given the excesses of the financial services industry collapse that started in mid-2007.

Most people can and should try to learn the main elements required to make good investment decisions regardless of the choice of investment vehicle.

* Please sign up to my mailing list (top right of the page) if you would like to receive details about how to obtain a copy of the ebook.

The Kirk Report once again produces an impressive post entitled “Reading Less, Practicing More & Getting Experience” that reinforces the need to practice actually putting capital at risk to learn trading effectively.

The thrust of the article brings into focus many of the benefits that the Texas Holdem Investing method brings to learning how to trade.

Practicing is an essential part of learning to invest, and this can only be achieved by investing and trading with real capital.  And the most important elements that need to be practiced are emotional discipline, risk management, and adhering to trading rules.

However, for the uninitiated, starting to put capital at risk to practice investing straight away if a difficult option to pursue, and is likely to result in capital loss.

Texas Holdem Investing is a solution to this problem.  A novice investor who is learning the fundamentals of security and markets analysis, can use poker as a way of practicing emotional control, risk management, and rule adherence with smaller amounts of capital then required for investing and with a greater speed of practice.

Learning and playing poker can also demonstrate the value of another one of the points raised in the Kirk Report article, namely that too much reading / information can be detrimental to trading.  A poker player can read about strategy and how to play hands for a long time with little effect on the player’s skill base.  In fact, having too much information in a player’s head can obstruct the development of natural intuition which is critical to good play.  Similarly, too much analysis can obstruct a trader’s ability to get synchronised with the markets.

To paraphrase (and slightly alter) one of the final quotes from the Kirk Report piece, poker is a learning experience for investing like no other, since you have to put real money at risk in a controlled fashion and you experience the “heavy emotion” of the pain of loss and the thrill of wins – just like in the world of trading and investing.

Garry Kasparov, the legendary chess champion has written a fascinating article entitled “The Chess Master and the Computer” in the New York Review of Books. The main subject of the article is a precis of a book entitled “Chess Metaphors: Artificial Intelligence and the Human Mind” which is written by Diego Rasskin-Gutman.

However, despite the subject of much of the article being chess Kasparov makes some remarkable comments with relevance to the Texas Holdem Investing concept and how perhaps poker may now be the best game for teaching risk.

The core subject of “The Chess Master and the Computer” is how the advent of chess supercomputers has changed the face of the chess world, and in many unpredictable ways.

Game (and Investment) Outcome Space

Early in the article Kasparov refers to the interesting analogies that are used to explain the vast range of potential moves in a game of chess. One of the more powerful metaphors used is that when a chess player attempts to look out 8 moves there are as many possible games as there are stars in the galaxy!

At the end of the article Kasparov then talks about how poker has all of the complexity of chess, with the added layer of incomplete information (chess players can see all of the pieces), which may mean it is a better medium for teaching about making decisions in uncertain environments. Clearly the investment world to be one of the ultimate uncertain environments, thus making poker an ideal tool for learning the core concepts of investing.

Education of Chess Players (and Poker Players and Investors)

One of the unintended consequences of chess supercomputers is that younger players who are familiar with computers can now play and learn against “professional” chess supercomputers from the comfort of their home. The ability to learn at such levels has created a new breed of chess masters, often from unlikely countries such as Norway.

The relevant point here for Texas Holdem Investing is how the internet allows poker players and investors to train at their craft from anywhere in the world – you don’t need to be based in New York or Chicago (for investing) or Las Vegas (for Texas Holdem).

Kasparov also notes that playing chess on computers where there is access to information on the right types of moves and strategies has helped players accelerate and compress the learning process for chess. Kasparov refers to the well-known “10,000 hours to expertise” cited by Malcolm Gladwell, and seems to imply that computerised chess learning has compressed the amount of time it takes to reach the 10,000 hour mark.

This idea is an integral part of the Texas Holdem Investing concept and program. Learning by computer does not reduce the 10,000 hours, it just makes it a lot easier to get there in the shortest possible space of time. Essentially, one can play more scenarios in a shorter space of time, and can access a vast computerised database (the Internet!) of information on strategy improvement.

This theory of fast-forward learning that can be achieved for investors in terms of the key skills of risk management, investing discipline, and emotional control is one of the unique benefits of Texas Holdem Investing (for a longer discussion see “Texas Hold’em Poker – The Fast Forward Button for Investment Training”).

Poker is better than chess for teaching risk in current times

Kasparov finishes off the article with an incredible observation by a former world chess champion who clearly still retains a passion for the game of chess.

Kasparov proposes that chess may be the wrong game for our current times and that poker may be more appropriate. He notes that poker is a game of imperfect information and variable stakes which means that players can learn to appreciate the effects of risk management, chance, and bluffing. As Texas Holdem Investing notes, these are three critical elements in the sphere of investing (bluffing is not always an obvious aspect investing, but try telling that to someone who loaded up on Enron stock based on the reports from management).

The chess master notes that poker outcomes are significantly dependent on human psychology, which indeed is a critical aspect of navigating the investment world. Kasparov feels that perhaps poker can help individuals learn how to take risks and so the mass take-up of the card game is not a bad thing.

According to Kasparov learning poker can teach people that there are no rewards with out corresponding risk. This is one of the most vital lessons that must be learned before putting your money at risk in the investment world. Texas Holdem Investing shows how to systematically approach learning poker so that you can embed this lesson into your mental circuitry before swimming with the investing sharks.

There have been a number of articles about poker and investing since the start of 2010 which is always great reinforcement for the Texas Holdem Investing concept.

Kiplinger recently posted three articles about poker and investing which I felt were very comprehensive on the subject.  This post reviews the Kiplinger articles through the lense of the Texas Holdem Investing concept.

I will also expand on a couple of sections of the Kiplinger articles which discuss the merits of using “free” poker to learn to invest and how this is at odds with a core part of the Texas Holdem Investing thesis: learning to invest by playing poker with real money at risk.

“How Deepak Chopra Helped Me Play Poker Better”

Bob Frick describes how in 2005 he made the connection between poker and investing with a biofeedback tool promoted by Deepak Chopra.

In an effort to improve his Texas Holdem play Bob hooked himself up to the “Journey to Wild Divine” biofeedback that measures stress and discovered that when playing Texas Holdem poker his stress levels became elevated.  He then performed the same test when he was making financial decisions and found that the same stress elevation occurred.

This outcome is an interesting proof of the theme from Texas Holdem Investing that poker can be used to train your psyche to deal with the stress of making financial investment decisions where your money and capital is at risk of loss.

While an excellent article early in the piece Bob discusses how he learned to play Texas Holdem Poker through playing “free” games on America Online.  Apart from learning the basic rules, Texas Holdem Investing strongly advises against using free games to learn poker and to discover your emotions.  When no money is at risk you simply will not react the same was as when money could be lost, even if the amounts that could be lost are small.  After learning the rules you must start playing for real cash – even if it is at the 1c/2c limits.  Like any training regime you need to start off small, but playing free poker is like paper trading – of limited usefulness as an education tool for real investing.

“How Texas Hold’em Simulates Investing”

This article describes why Texas Holdem is the closest form of gambling games to investing because players with greater skill levels will generally “outperform the market” compared to less skilled players.  Frank Murtha states that the goal of Texas Holdem is “to accumulate capital based on decisions with imperfect information” – the part in quotes is an exact description of investing.

The article describes how the various phases of Texas Holdem are analogous to the phases of an investment decision.

• Evaluating starting hands is similar to reviewing the investment opportunities available to you.  The small and big blinds are an analogy for your costs of an information and investing platform.
• Making a bet is similar to making an actual investment
• Then the (investment) flop occurs and you must review the investment based on new information, which is still incomplete because you don’t know what your opponents hold.
• If you are still in an investment at the turn and river stage then it should be a very good security because you are likely to have committed a lot of capital

At each stage of Texas Holdem poker you must make the decision to put more capital at risk (or leave the same capital at risk) or to cut the investment based on new information.  Playing Texas Holdem can help you develop your own evaluation framework for your investment decisions.

The article closes with a statement that it is not necessary to play poker with real money to identify your psychological makeup that may affect your investing.  The article mentions various investment psychology experiments that did not use real rewards, but I would question the full value of such experiments in terms of simulating the real world.  However, as stated previously playing “free” poker to learn to invest is like “paper trading”.  It misses out a huge element of real like investing (and poker) – the fear of losing money and the elation of achieving gains, and how these raw emotions can affect your performance.

“How Poker Can Make You A Better Investor”

This piece focuses on a number of important issues that make poker an excellent tool for learning to invest and trade, with a focus on how poker teaches the emotional side of investing.

The article notes that a number of market practitioners such as Andrew Lo of MIT, Aaron Brown formerly of Prudential Securities, and Frank Murtha of MarketPsych state that poker can help investors develop the emotional stability necessary for investing.  This is a fundamental part of the theory of Texas Holdem Investing where Step 4 explains about managing emotions through the following steps:

• Understanding your emotions – when you play Texas Holdem with real money you will learn about how your emotions react to winning and losing and having to make decisions where real money is at risk
• Gradual emotional training – Texas Holdem allows you to start at low risk levels to gradually increase the intensity of your emotional training.  Investing generally has to start at much higher capital levels, where investors typically have no emotional frame of references, particularly for losses.
• Removing your emotions – Texas Holdem helps teach the development of rules-based systems that remove emotion from investing, and also the discipline of stopping activity in the face of a sequence of losses to take time to prevent your emotions from causing problems.

The first section of the article discusses about how poker can permit a learning investor through many financial decisions in a short space of time and so accelerate the learning curve while putting limited amounts (or no) money at risk.

Although playing a few hours, or an evening of poker can certainly help an investor learn more about their emotional make up I think that this is insufficient as a method of learning about your investing through poker.

The Texas Holdem Investing thesis is that poker should be played on an ongoing and rigorous basis with real money at risk for a long period before a new investor puts any investment capital at risk.  Further to this concept, a learning investor should be able to consistently win at poker for a reasonable period of time before committing capital to the investment markets.  Unfortunately not everyone is suited to the investing world and may be better off applying their skills elsewhere in the world of finance.  Following the Texas Holdem Investing concept can help a person to find out their suitability for investing without losing huge amounts of investment capital over a long period.

One of the advantages of playing a large number of poker hands is that it demonstrates how long it can take to get from a small starting capital amount to increase it.  A real life example carried out by one of the most well known poker professionals – Chris Ferguson – was where he tried to build up to a $10,000 bankroll starting off from zero.  The results of the experiment are described here, in addition to some rules that Ferguson developed for poker which are equally applicable to investing.  By building up your own poker bankroll to $5,000 or $10,000 you will learn the time and effort it takes to make money in the investing markets.

Play Real Poker To Learn Investing

Playing poker casually and for free, like “paper trading”, can help shed some light on your investing capabilities and emotional composition.  However, it is only by playing it with rigour and over a long period of time that it can help to teach and improve your skills at investing with real capital at risk.

Part 1 of this post series discussed why sports analogies should be used with care when discussing their relevance to investing and trading. With those points in mind Part 2 goes through Dr. Bob Rotella’s 10 Rules on Mental Fitness from and notes some areas where the interpretation of Dr. Rotella’s rules for golf should be made with care in the context of poker and investing. Being an amateur golfer myself, I do have a little bit of insight as to how to make the transition. In the title of each rule there are brackets to indicate investment and poker related amendments.

Rule 1: Believe you can win (over the long term)

Generally in sports to do well the player needs to do a high percentage of things right. If an investor holds out that standard as being necessary it will only lead to heartbreak. It is a recognised fact that even the best investors and traders (and poker players) lose on up to 40-50% of their investments. But it is how they handle the losses (cut them) and profits (maximise them by letting them run as long as possible) that makes the difference. There is one golfing analogy that is somewhat appropriate here. The great Ben Hogan once said about golf that “This is a game of misses. The guy who misses the best is going to win”. It is the same with investing and poker. You need to believe not just that you can win, but that you can extricate yourself from your bad decisions effectively. This will increase your chances of winning in the long term.

Rule 2: Don’t be seduced by (near term) results

This rule is appropriate to poker and investing on both sides – the up and down. Near term results that have recently occurred should not influence your strategy and tactics. The natural volatility inherent in both poker and investing means that short term results can seem to be much worse or better than expected. Such deviation from long run expectations should be ignored, although given the strength of human emotions particularly in the face of losses this is easier said than done. Playing a lot of focused Texas Holdem poker can help to train your emotional responses in the face of such losses to prepare yourself for the larger field of investing.

Rule 3: Sulking (and going on tilt) won’t get you anything

This rule is true with sports, poker, and investing. Sulking and getting emotional about a situation that has gone against you is most likely to make your performance worse. Dr. Bob explains how Padraig Harrington’s acceptance of a terrible last hole in the British Open in 2007 was what helped him to move on to the play off and then win it despite his terrible play (and luck) on the 18^th. Similarly, in investing (as with poker) it is vital to put bad investments (and hands) firmly behind you and move onto the next play.

Rule 4: Beat them with patience

Patience certainly is important in the poker and investing worlds, as it is with golf. One needs to wait for the right starting cards or the right type of investment that meets your screening criteria. However, the patience in poker and investing is somewhat different to that needed for sport. Tom Kite did indeed patiently shoot par on the last day of the US open, but he had to do a lot of work to hit par. The patience necessary in poker and investing is to be able to wait through long periods where nothing is happening and you are not making any plays.

Dr. Rotella’s advice to always make the conservative play is sometimes incorrect for investing and poker. When things do go your way with an investment or poker hand, typically those situations can be where you make the largest returns and you can often only hit the high returns with some level of aggression. Don’t throw caution to the wind, but do push your luck when it comes knocking.

Rule 5: Ignore unsolicited swing (and poker / investing) advice

The only person who knows how you invest or play poker is you (and perhaps your mentor if you have one).

Unlike golf, you are less likely to get unsolicited advice on how to invest or play poker. What you are likely to get is large amounts “tips” on the next hot stock or security. You should disregard all the “experts” and continue to focus on your own methods.

Rule 6: Embrace your personality

Dr. Rotella suggests that you should operate on the course according to your personality. Unfortunately, there is a prior decision you need to make regarding your personality and investing (or poker). That decision is: does your personality suit the markets or the poker table. Sometimes your current personality may not be the right one to embrace before you hit the tables or the stock exchange.

The good news is that with training it can be possible to manage (or at least tone down) the parts of your personality that won’t work in the worlds of investing and poker.

So, you may need to alter your personality and then embrace your personality.

Rule 7: Have a routine to lean on

Dr. Rotella is a proponent of making his golfing students develop a routine for each shot. This helps to focus the mind on the shot at hand by providing some “hooks” for the player to hang onto amidst the maelstrom of tournament pressure.

This is a very good piece of advice for poker players and investors. Too often these pursuits are glamourized based on the money involved and the rush of emotion. In reality the player or investor should focus on calming down and trying to follow the same consistent methods that is used for each hand and investment.

Such a routine is particularly helpful as a way of helping players and investors to re-focus after either a huge success or a big loss. Typically after such events your mind is likely to wander and having a routine to fall back on can help bring you back to your normal methods and pace of activity.

Rule 8: Find peace on the course (or at the table, or in the markets)

Apparently golfers that have practiced hard often freeze when they get onto the course because they have built up so much pressure in their head that they cannot enjoy the game. So Dr. Rotella advises that you make the course your sanctuary where you can enjoy things without a fear of making mistakes.

The poker and investing worlds are actually fantastically interesting, made more intense by the involvement of your money. But you should try to focus on the interesting parts of the game and the market, and not solely zero in on your possible or actual mistakes. You will probably enjoy things a little more, and with less pressure on yourself you are likely to perform better.

Rule 9: Test yourself in stroke play

Stroke play in golf is where every shot counts, not like some of the other game variants (such as “stableford”) where if you shoot worse than a certain score on a hole you can only lose so many points. So Dr. Rotella maintains that to really test yourself you should play strokes as often as possible. One of the key elements of successful stroke play is risk management, because if you don’t watch your downside you could end up taking lots of shots on one hole.

And so it is with investing and poker.

There are types of investing (like options) and poker games (like tournaments) where your downside is limited to your entry price and your upside is considerable. Like with stableford in golf, playing and investing in these “limited downside” types of situations too often can cause you to lose your downside risk management skills. So force yourself to test your poker and investing abilities in cash games and cash markets.

Rule 10: Find someone who believes in you

“No person is an island” – John Donne.

And the same goes for poker players and investors and traders. Although these pursuits are solo occupations, you can always benefit from support provided by someone you know and trust. In particular, such a support person can help you when things are not going so well. Just like Ben Hogan’s wife wouldn’t let him give up golf when it was not working out, when you got on tilt or have a bad run of investments it helps to have someone who believes in you to help keep you going.

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The Masked Financier is not the only investment professional who has reviewed Dr. Rotella’s rules and applied them to the investing arena. Please read Charles Kirk’s take on Dr. Rotella’s rules at the Kirk Report.

This is Part 1 of a 2-Part post series.  Part 2 is available here.

Charles Kirk of the eponymous Kirk Report wrote a recent guest post entitled 10 Rules For Better Trading for Wall St. Cheat Sheet (which is produced by the Hoffman brothers, Damien and Derek). In the post Charles takes an article from Golf Digest – 10 Rules For How To Win Your Major – written by the sports psychologist Dr. Bob Rotella and discusses how the 10 rules in the Rotella article can be applied to trading.

As readers of Texas Holdem Investing know The Masked Financier is a promoter of the use of gaming analogies to explain the elements of investing and trading. And it is interesting to note that The Masked Financier has heard lately that Dr. Rotella has started to work with traders. However, one needs to exercise care when using sporting analogies for investing because in some cases the dynamics of sports situations don’t translate directly to investing and trading.

Clearly there are a number of elements that make sports an good medium for discussing the characteristics needed for good investing and trading.

• Ambitious players in sport need to practice hard by repeating similar actions again and again, learning from mistakes is essential, and commitment is necessary even when all seems lost.
• Risk management is an important part of sports, as is the case with investing.
• Performance and using good judgment under pressure is a key requirement for sporting excellence.

However, there are two major issues that mean sport is not an entirely appropriate framework for discussing, teaching, and learning investing.

• In sport the player can generally affect the outcome of the game (or situation within a game) by direct influence on either the player’s own performance or by affecting the performance of the other player(s) in the game. In most investing markets, the investor cannot in any way affect the performance of the securities that have been selected. There are some markets where the investor can affect outcomes such as private equity where the investors generally take control of the company being acquired and can make management changes. But these situations are in the minority and the average investor is often unable to access these asset classes. A good sportsperson may find the investing world somewhat frustrating because once an investment is made it is a case of waiting without being able to do anything pending a view on where the market moves. Even a team sports manager, while not on the field, can make changes to the team and its strategy.
• Commitment when all is lost is an important part of sports – often described as the “never say die” attitude. In the field of investing commitment to your business and trading plans in the face of poor short and medium term results is an important part of improving your likelihood of success. However, in the context of an individual trade, commitment when all is lost can be a serious flaw, leading to the phenomenon of “doubling down” on bad investments when clearly the original thesis has turned out to be wrong. This type of commitment to a lost investment cause in the face of facts can have negative effects on your investment capital levels.
• In sport the game itself generally does not involve putting money at risk. Naturally in professional sport the players’ salaries and winnings are affected by their performance, but the payment profile here is generally one of upside only i.e. playing badly in a game will never result in a player losing salary or prize money (unless in the case of foul play), just forgoing extra earnings. And clearly in amateur scenarios there is no money at risk at all. Since putting money at risk is such an intrinsic part of investing (and trading) this difference between sporting scenarios and investing needs to be taken account of carefully.

One recent unfortunate description of how prowess in sports does not necessarily lead to financial ability is a recent piece by the New Rules of Investing blog about the poor investment and financial records of professional athletes.

The next part of this post will provide an interpretation of Dr. Rotella’s 10 rules on golfing mentality from the perspective of the Texas Holdem Investing method. This perspective will also take account of the two issues described in this post.

This post is a guest post on WallStCheatSheet.

Part 1 of this post series introduced the concept of similarities between poker and investing. It then proceeded to describe 5 key areas of similarity. Part 2 now goes on to explain an additional 5 key elements where both fields share characteristics.

6. Unavoidable Expenses: Investing and Poker both have unavoidable expenses associated with playing.

In Texas Hold’em poker the obvious expense is that of the “blinds”. For 2 games, in each full set of games around a table, each player has to put up a certain bet amount before seeing any cards. Therefore, even doing nothing has a cost in poker. This is the cost of being in the game.

However, in poker there are other costs that are more hidden. The cost of getting to a casino if you’re playing in a bricks and mortar session, or the cost of getting the appropriate software and hardware to be able to play online (assuming that this is legal).

The obvious cost for investors is the commission paid upon entry and exit from an investment or trade. These costs have dropped dramatically even for retail investors, but they are still expensive in the context of realistic return targets. For example a standard medium-risk return strategy would look to achieve 10-12% annualized returns. If an investor is incurring combined entry and exit costs of 1% per investment, the investor requires gross returns of 11.5-13.5% to achieve net returns at the target level.

Another, more hidden cost for investors is that of acquiring information. Although basic pricing and news services are free (e.g., Yahoo Finance), if an investor is serious about making money, it would be necessary to pay for more targeted and up-to-date news and pricing services. Further, even if the information is free, there is a time cost involved. So, to get in the game one must ante up with commissions and information costs.

7. Performance Analysis is Vital

Both poker and investing lend themselves well to performance analysis. At the end of each game and investment trade you will have a number of statistics about what happened. Analyzing these performance statistics is essential to identify problems with strategy and to help improve results over time. Unfortunately both poker players and investors tend to neglect this element of their respective fields. As a result, they experience continuous losses and no improvement.

Both fields often cause the player to learn more from losses than gains. Therefore, although losses are painful, since they cannot be avoided they do provide the benefit of a learning opportunity.

In Texas Hold’em poker there are three main sets of statistics which need to be analyzed. These statistics must be collated and analysed both individually and collectively to ensure that a player has a full understanding of all aspects of gameplay and bankroll management over time:

• Game statistics show betting patterns based on the pocket cards, table cards, and the betting of opponents;
• Session statistics are the aggregated game and bankroll statistics of each session, which demonstrate how game statistics change during the course of a session and how bankroll risk is managed; and,
• Bankroll statistics demonstrate the progress of your bankroll over time in terms of changes to total size and the amounts put at risk relative to the types of limits played.

Similar to Texas Hold’em, investing has different sets of statistics for each element of the investment process:

• Screening statistics are often overlooked statistics for investment professionals and warrants a separate discussion here. Its analogy in Texas Hold’em poker is the percentage of pocket cards played out of total hands dealt. Because this is an explicit part of Texas Hold’em, it is easy to measure. But investors on the other hand rarely give consideration to how many times they trade compared with the amount of trades they evaluated. Overtrading, a problem that affects many investors, starts at this stage and monitoring this statistic can help reduce it;
• Individual Investment statistics show the trade size, holding period, change in position size during the investment, and exit data including returns;
• Portfolio statistics provide details of the aggregated investments across a portfolio over a selected period of time to identify trends in the aggregated individual investment statistics; and,
• Capital Management statistics demonstrate the changes in your overall capital over time based on the investments made. The statistics that must be analyzed are mainly based around the volatility of the change in capital levels and the reasons behind the volatility.

8. Constant Risk Management: Risk management is necessary at various different levels in both poker and investing, and the levels are similar to the types of statistics discussed in the previous section.

In Texas Hold’em the player needs to first manage overall bankroll risk by ensuring that the bankroll is of sufficient size relative to the target limit levels being played. Then session risk needs to be managed — in particular to focus on avoiding going on tilt in response to poor results. Finally, game risk must be managed based on how the cards evolve and in relation to the amount of your money in the pot and what is required to stay in the game relative to the game situation.

Investors need to manage their overall capital in relation to the trade sizes. The risk needs to be managed for each investment based on the amount of capital invested and how the trade performance has played out relative to the original investment thesis.

9. Emotional Control: When poker players and investors are subjected to the strains of monetary losses, profitable gains, and volatility of their accumulated capital, it is inevitable that emotions will run high … unless you have some Vulcan in you.

Therefore, developing your ability to control emotions in the face of such a financial rollercoaster is one of the core elements of being a successful investor and poker player. Losing emotional control, particularly when results are going against you, is often devastating for your overall return levels. The term used for this loss of control in Texas Hold’em is “going on tilt” where typically the player starts making more bets than is rational based on actual cards in an effort to recoup losses.

It is true that certain individuals have a better psychological disposition to deal with the emotional rigors of poker and investing. Despite different emotional dispositions it should be possible for the majority of people to acquire the emotional control necessary to achieve success. However, there is only one effective way to develop this control, and that is by actually playing poker or investing with real money. Only then can a person find out what emotional responses actually occur in response to wins and losses. Following the discovery of this emotional feedback, the player or investor can start to work on controlling the urges effectively.

10. Discipline

This is probably the most critical similarity between Texas Holdem and investing. It is intertwined with all of the previous points raised. Discipline needs to be maintained from the start of playing poker and investing to maximize the likelihood of success. Like emotional control, discipline may need to be acquired because not everyone has it to start with.

It takes discipline to get through all of the issues above, ploughing a solo furrow, developing a business plan, maintaining a serious approach, dealing with the vagaries of luck, learning probability, managing expenses, collecting and analyzing performance data, managing risk on an ongoing basis, and controlling your emotions.

Conclusion

The comparisons between Texas Hold’em poker and investing discussed in these posts produce a compelling rationale for using poker as a tool to help improve an investor’s skill set. Learning the skills that are required to be a good Texas Hold’em player can help to increase your understanding of how to invest sensibly, profitably, and with low risk levels.

To read Part 1 of this series, click here.

This post is a guest post written for WallStCheatSheet.

Peter Lynch – one of the most well known US money managers – has written that one of the most valuable educational tools for a would-be-investor is playing poker. Other investment titans also have great regard for the skills that an investor can learn from playing Texas Hold’em. These include Bill Gross, David Einhorn, Steve Cohen, and even Warren Buffett. Buffett has preached his investment wisdom using the medium of poker more than once.

However, many investors feel that poker is simply a form of gambling where there is a significant element of luck involved. They find it hard to believe poker is similar to investing and can be used to teach investing. As I will demonstrate below, these two beliefs are untrue.

Note: In the title and the rest of this post you will see references specific to Texas Hold’em poker. This type of poker is generally regarded as one of the most complex forms of the game. Therefore, Texas Hold’em is one of the best poker forms to teach investing concepts.

There are many similarities between Texas Hold’em poker and investing:

1. Solo Occupations: Both investing and poker are ultimately solo occupations.

People are well aware that poker is a solo occupation because only you can sit down at the table and start playing. Ultimately, investing is essentially a solo occupation too. There is only one person who finally pulls the trigger on making an investment or a trade. Yes, that person may have support from a team of researchers, but when it comes down to putting the money on the line there is only one person who can make that decision.

Another way of demonstrating how investing as a business is a solo occupation can be shown by comparing investing with other types of businesses. Granted, many businesses can be operated by a sole trader. However, in most cases they won’t scale up well. You can’t manage a company like GE without a support cast of thousands. However, Warren Buffett can control the entire wealth of Berkshire Hathaway from Nebraska, simply making investment decisions on his own (well okay he gets some help from Charlie Munger).

2. Business Plan Required: If you want to invest, trade, or play Texas Hold’em successfully, you need to develop a business plan and learn the patience to adhere to this plan.

This is one of the most important parts of good investing and poker play, yet it is probably the piece of work that is ignored most often by both investors and poker players. A business plan for Texas Hold’em poker should outline the following aspects of your poker strategy:

• The type of games you will play (e.g., limit, pot limit, no limit, cash games, or tournaments);
• The game strategy you will use which should tie in with your chosen game type, skills, and mentality (i.e., tight or loose aggressive);
• The bankroll you will need to start playing with — both at an overall level and for each game you play;
• Your “limit movement” strategy (i.e., how you will increase/reduce your limit levels based on your results); and,
• How you will record and analyze your performance.

The similarities with an investment business plan are remarkable. Such a plan must incorporate the following elements:

• The type of securities in which you will invest (e.g., stocks, futures, options);
• The strategy you will employ when investing which should be based on the type of security you are investing in, your investing abilities, and your emotional capabilities;
• The starting capital you will need to have before beginning to invest — both for each investment and at an overall level;
• Your investment sizing strategy which would be based on your overall capital level, risk strategy, and ongoing performance; and,
• What tools you will employ for recording and analyzing you investment track record.

3. Serious People Make Money: When practiced properly by serious people, both activities are done with the objective of making money.

Many professional poker players have become famous since the mass promotion of the World Series of Poker: Doyle Brunson, Phil Hellmuth, and Chris Ferguson (and don’t forget the Texas Hold’em Investing hedge fund supremo David Einhorn). These players all focus intensively on their poker and it is often their sole source of income. No Friday night games with the friends for these players. And it isn’t all glamor either – sitting out long runs of bad hands in half empty casinos isn’t exactly Hollywood. Unfortunately the non-serious players typically lose all their money with the exception of the rare big win which keeps their interest.

The difference between the serious and non-serious people in investing is much more tragic than in Texas Holdem Poker. The serious investors also generally support themselves fully with their gains from investing. They focus fiercely on the markets and concentrate on analyzing them as much as possible based on their various strategies. The names are well known – George Soros, Warren Buffett, Ken Griffin, Peter Lynch, and we can also look to the example set by the various traders interviewed here on Wall St Cheat Sheet by Damien and Derek. However, at least the non-serious poker players aren’t in it to help secure their retirement. The non-serious investor tries to put money to work in the markets without sufficient preparation, research, and determination. This typically leads to inadequate relative returns, or even worse, complete losses of capital.

4. Element of Luck: There are elements of luck in both fields in the short-term, but in the long-term the skill of the player/investor should be expected to result in financial gain.

Short-term luck in poker and investing cuts both ways – good and bad. In Texas Hold’em Poker good luck can come by being dealt AA pocket cards, which then helps to win a big pot. Or, luck can come when the river card completes a flush to beat the opponent with three of a kind. On the other hand, the bad luck can come when the AA pocket cards with a third Ace on the flop is beaten by the amateur who started with 27 offsuit and ends up with a poker of 7s. But in the long-run, the good player will maximize the benefits of good luck and minimize the damage of the bad to produce an ultimately positive return.

Luck in investing is based on the fact that despite endless analysis and research about a company, a security, or a market, something unexpected can always happen that causes an investment to perform better or worse than expected. BP can find new oil in the Gulf of Mexico. Ebay can sell Skype for nearly the purchase price. These are both examples of good luck. On the other hand, Washington Mutual can announce it has run out of funds not long after one of the smartest private equity managers invested billions of new capital. Or, Bear Stearns can go nearly to zero out of nowhere before being acquired by JP Morgan.

The intelligent investor will ensure that the portfolio is constructed in such a way that it can survive such incidences of bad luck by sizing investment positions appropriately. At the same time, good luck can be taken advantage of by letting the profits from a position run as long as possible after the good news has emerged. Thus, the strong investor will never be immune to the effects of luck, but can manage the portfolio in such a way to benefit and protect from luck where possible and help achieve long-term positive returns.

5. Knowledge of Probability Needed: Investing and poker both require a knowledge of probability and statistics for the “player” to perform well.

Poker requires players to evaluate approximately the probabilities of winning a game based on the player’s pocket cards, the cards on the table, and the likely cards held by the other players. The key concepts are:

• Pot Odds – comparing the amount expected to be won in a game with the probabilities of winning based on the current situation;
• Implied Odds – adjusting the Pot Odds to incorporate the likely future betting which will occur in the game; and,
• Expected Value – the long-term value of the current situation for your hand based on how effective the hand is over a large number of hands, which would smooth out the effect of bad beats and good luck in the short-term.

Statistics knowledge is also important for poker when analyzing the results of your play, determining how effective you have been, and where are your weak points.

Investing requires knowledge of probability in order to calculate the expected value of your planned and actual investments based on the probability universe you have developed for the investments according to knowledge of the situation. This way of thinking allows you to compare the risk and reward elements of each investment in a rational way which prevents emotion from overtaking your thoughts process.

Part 2 of this series will continue the description of similarities between poker and investing with the final five key elements.

Nassim Taleb’s best-seller - The Black Swan: The Impact of the Highly Improbable – proposes the Ludic Fallacy as a significant contributor to financial crises that have plagued the modern world.

The Ludic Fallacy states that games are used too often to help people model, learn about and think about real life situations.  Taleb hypothesises that this causes problems because the defined rule sets of games do not take account of the full range of uncertainties that exist in the real world.

However, having read through the relevant section of the book I disagree with many of Taleb’s points, and have found other parts of the book that contradict the Ludic Fallacy.

As you can imagine I have a vested interest in disproving (or exposing the fallacies of) some or all of the Ludic Fallacy since Texas Holdem Investing is based on using the game of Texas Holdem Poker to train people to invest.  However, it is not just a vested interest – it is a passionate belief of mine that games can provide a great environment to learn about the real world.  Clearly there is no substitute for the real world, but using games appropriately and ensuring that they are realistic enough can certainly help.

This article argues about why (Texas Holdem) Poker goes against many of the elements of the Ludic Fallacy, and also explains why we shouldn’t be harsh on games as a way of learning all the time.

Texas Holdem Poker has uncertainty based on the cards that are dealt but also based on the unpredictability of the actions of the players.  This makes the set of potential outcomes infinite even in the context of a 52-card universe, unlike games against the house e.g. roulette, which Taleb often refers to in his discussions of the Ludic Fallacy.  Therefore, Texas Holdem Investing will help the learning investor to become familiar with the infinite randomness of the financial markets.

The training regime of the military is totally based around the ludic concept – they even go so far as to name many training exercises “wargames”!  And Taleb actually uses the Black Swan book to praise the military thinkers who he encounters at one point as being far more capable than some of the other strategic and financial planners he meets.  Clearly the military don’t believe in the Ludic Fallacy – otherwise they never would have set up the Top Gun school in Fightertown, California.

Another example of the military using a “gaming” environment for training is the US Special Forces camp at Fort Bragg which uses extreme methods to help soldiers gain some insight to the terrifying experience of being captured.  I have written about this in more detail on the post entitled “Investing and Poker Lessons in Survival – Can we all be like Jack Bauer, James Bond, Phil Hellmuth, or Warren Buffett?“.  In this “game” special forces trainees are subjected to extreme stress as part of a live battle and kidnap simulation.  Clearly it is not the real thing, but I’m pretty sure that going through this kind of “game” helps prepare the soldiers in some way for the stress of the battlefield.

And what about one of the most well known “game training” systems of them all – the flight simulator.  Thousands of pilots are trained how to fly a huge jet with hundreds of passengers through the medium of a computer simulator that (as per Taleb) only has a finite number of possible outcomes.  Yet they end up graduating just fine to fly the real thing with amazing safety records.

And perhaps the most important proof of all that poker doesn’t suffer from the Ludic Fallacy comes from Taleb himself!  Yes in Aaron Brown’s fantastic book – The Poker Face of Wall Street – Taleb provides the foreword and he highly praises poker as benefiting from the Ludic Virtue.  Poker offers true randomness according to Taleb due to the infinite levels of “social probability” caused by the actions of other players (see above).  And he finishes off the foreword with the phrase “Economic life is gambling”.  My own derivative would be “Investing is gambling, just like Texas Holdem Poker”.

So, after all that, Taleb admits that poker doesn’t suffer from the Ludic Fallacy, and I think that I’ve given some good reasons as to why “games” can provide good training even for extreme situations in other walks of life.  And let’s face it, investing can be pretty extreme at times.

Marketers often talk about creating a brand, and that’s what I’m trying to do with Texas Holdem Investing.

“They” (the marketers) say that an important part of developing a brand is to have “hooks” that remind people of your brand.

Well I’ve just found my musical hook – “The Gambler” by Kenny Rogers.

“The Gambler” is one of most legendary country music songs ever written and the album with the same name hit number 32 on About.com’s list of the top 200 most influential country songs ever.

Investors could do well to read and absorb the lyrics of this song – the man speaks the truth!

For some fun and diversion myself amidst all of my “serious” posts, I decided to pen my own version of the lyrics inspired by the mythical figure of “The Trader”, an mysterious and sphinx like character who is the equal of The Gambler.

I hope you like them and might learn from them.

And perhaps some day I’ll do my own karaoke version for YouTube – wearing a purple jacket just like Kenny!

The Trader – By The Masked Financier – May 2009

On a hot summers evenin on a steakhouse down near Wall Street,

I met up with the trader; we were both too wired to sleep.

So we took turns a starin at the quotes on the Bloomberg

Til boredom overtook us, and he began to speak.

He said, son, I’ve made a life out of readin annual statements,

And knowin what the profits were by the way the CEO’s talk.

So if you don’t mind my sayin, I can see you’re out of aces.

For tastin some your Lynch Bage Ill give you some advice.

So I handed him my bottle and he poured himself a half glass.

Then he took out a Cohiba and asked me for a light.

And the room went deathly quiet, and his face lost all expression.

Said, if youre gonna play the game, boy, ya gotta learn to play it right.

You got to know when to hold em, know when to fold em,

Know when to walk away and know when to run.

You never count your money when youre sittin at the Bloomy.

Therell be time enough for countin when the stock exchange is closed.

Now evry trader knows that the secret to survivin

Is knowin when to cut a trade and knowin when to stay.

Cause evry trade’s a winner and evry trade’s a loser,

And the best that you should aim for is 10-15 a year.

So when he’d finished speakin, he turned back towards the Bloomy,

Crushed out his Cohiba and zoned into the flow.

And somewhere in the darkness the trader, he broke even.

But in his final words I found an ace that I could keep.

You got to know when to hold em, know when to fold em,

Know when to walk away and know when to run.

You never count your money when youre sittin at the Bloomy.

There’ll be time enough for countin when the stock exchange is closed.

You got to know when to hold em, know when to fold em,

Know when to walk away and know when to run.

You never count your money when youre sittin at the Bloomy.

There’ll be time enough for countin when the stock exchange is closed.