During the current corona crisis I interpret the ongoing social distancing measures quite strictly for myself. Meaning, I have not meet friends for dinner or for a drink or anything else (besides for a running) in real live for a few weeks now and! it! sucks!. So, I had to come up with a better solution for my evenings than watching TV each day …
Since I like playing table games with friends very much in general, we started to do that online. It turned out quickly that playing poker online worked best (with whysky🥃😉), at least, technical wise since some providers were just overwhelmed from too many new users.
We used to play poker a lot, almost on a daily basis if I remember correctly. More than 10 years ago, I always enjoyed the game and perceived myself as an interested and talented player with an above average* understanding of the game. In fact, I even read a book about some advandced cash game strategies with a good portion of statistics involved. Since it has many similar features to investing, like the following, I write this post.
Different games have differnt features.
- hidden information – information that is not observable to you
- skill – the decisions you make
- luck – randomness in past, and more important future events
*) It depends a lot on what group you derive the average from.
**) Let’s say luck involved in chess is very limited: the strength of your opponent.
Update April 29, 2020: According to a Morgan Stanley paper, investors can express skill in three ways: market timing, security selection, and position sizing.
Discussion Starter for this Topic
Howard Marks memo You Bet! from a few months ago discusses many parallels between gmabling and investing. Most of them were not entirely new to me. But anyway, now that I started playing poker again (and having much fun doing it!), I wanted to revisit his key messages and concepts included in his writing. They became even more intuitive to me while playing poker these days. Btw, we play hold’em no limit, cash game.
No limit cash game is the most relevant poker type with regard to investment topics, I believe. This is because in a sit and go (poker tournament) if you are out you are out. In a cash game you can re-buy into the game. Thus, each hand and bet can be considered on its own. Limit-games lead to a more complex game strcture.
What is a Bet?
According to Annie Duke
a bet really is a decision about an uncertain future.Annie Duke, Thinking in Bets
The outcome of such bets (and our lives) is determined by (i) the quality of our decisions and to a certain extend (ii) luck. What makes a decision great, is not the (great) outcome, but a good process trying to accurately represent our state of knowledge. This definition perfectly lends itself to investing.
Improving our decision quality is about improving our chances for a positive outcome, not guaranteeing one.
We have to make peace with not knowing …
When placing a bet it is not always smart to bet on the likely winner or favorite. Instead, betting decisions are all about assessing the proposition.
Our State of Knowledge
The state of knowledge summarizes what you do know and what you do not know. Of the available information you can know up to 100%, but in poker and in investing you will sometimes miss some bits of available information. The hidden information (i.e. your opponents cards) is per definition not known to you; sometimes you can make an educated guess, though. Statements should begin with variations of “I am not sure, but …”.
When a smart poker player enters the casino, he wants to sit down at the right table to maximize his profits. He wants to play against weak(er) players, maximiszing his wins by taking advantage of the weak(er) competition. In the same way, it might be a good idea to
Look for investments in less efficient markets (competition) or market segements as an investor. These might be emerging markets or a segment of companies with lower market capitalizations, which tend to be followed by fewer analysts or (potential) investors. Marks differentiates between so called alpha and beta markets. Ones circle of competence also is an important feature.
We do not have to play every hand after taking place at a certain poker table (or after investing in the equity market)! We can wait until we get a particularly strong hand (or attractive investing proposition). This involves being capable of analyzing and understanding the current situation and having the odds on your side.
When I was in Hong Kong, I spend many evening at the Happy Valley Racecourse watching horseracing – and sometimes betting, only for fun, though! Btw, I will publish an article featuring an interesting investment opportunity in Hong Kong soon. Back to explaining a proposition by reference to horseracing:
Let’s say there are two horses: One lean with a great track record, obviously the favorite. And one overweight with a lousy track record. And you can enter one of the following bets:
- betting that the lean horse wins, with a payout of 5:4
(if it wins you get $5 for every $4 you bet; implied probability for winning is 80%)
- betting the lousy horse wins, with 5:1
(if it wins you get $5 for every $1 you bet, impl. prob. 20%)
Let’s assume, based on the available information you guess the probabiliteis that either horse one (75%) or two (25%) wins. Let’s further assume your guesses are (very close to) reality. You as a smart better (investor) would bet some of your money on horse two. Depending on how riskaverse you are you would bet even smaller amounts.
A proposition is defined by (i) the offered price and (ii) the real (intrinsic) value of the bet. Additionally, you have to take into account (iii) the role of luck (or randomness). Furthermore, you have to assess (iv) the importance of hidden information.
The ability to deal intelligently with hidden information has to be based on skill.Howard Marks’ Memo You Bet!
In the end, poker (investing) is about finding superioir propositions (investing opportunities) or mispricings. A proposition is more attractive to you (me) the bigger the mispricing (exp. profit) and the smaller the role of luck (range of outcomes) taking into account the degree of hidden information. From Howard Marks’ Memo You Bet!:
When to Bet Heavily?
You have to figure out what to bet on (outcome) and when to bet heavily. In poker, the most comfortable situation is when you have the best possible hand or nuts, meaning you will not loose (assumed cards to be dealt can not change that). If that is the case, your only goal is to maximize your winnings by luring the most chips into the pot from other players and to bet heavily – I experienced this situation a few times now. The case is so compelling, since the factors luck (or risk) as well as hidden information (holding cards of your opponent) are eliminated (do not play a role anymore). Sure, your opponents holding Cards will influece what amounts he might call. Worst case, though, is he has also nuts and it’s a spilt pot.
In general, how much to bet depends on the overall attractiveness of the proposition. Betting more …
- the bigger the mispricing (intrinsic value minus fair price)
- the lower the risk (or uncertainty involved)
- the better the proposition relative to alternatives (bets, investment opportunities, including doing nothing)
Am I a Gambler?
To answer the question from the title: I am a gambler in the sense that I do play poker (and other games with the above described elements), but I have a calibrated sense for the odds and the attractiveness of the proposition. Besides that, I just enjoy the game using my (perceived!) skill 🙂
PS: To be honest, I enjoy poker and other games the most playing with @my friends, since besides playing the odds I just spend a good time talking to friends.
I wish you a nice weekend, and as always I end my post wishing you
happy investing good luck 🎲🎲