Wednesday, May 10, 2006

Investing and Poker: Entry and Exit Points

Bless you, Cryptologic. I take back all the mean things I said about you.

I'm still playing little poker, but I'd by lying if I said it was completely out of my head. At the same time, I've been spending much more time researching stocks and generally immersing myself in the world of investing. And I can't help but see lots of parallels between the two endeavors.


Buy Low, Sell High

Everyone has heard the trusty investing saw: buy low and sell high. Oversimplified, sure, but it's hard to argue with. When we invest in something, we're taking a position with a belief that it will appreciate in value in the future. Usually we take that position based on research, knowledge, experience, and/or the general belief that we're more skillful than the average person in evaluating and recognizing value.

When we take an investment position, we're evaluating the existing data and making what we believe to be is a +EV investment. Does that mean we'll make money off of every investment, even if we're the most knowledgable, skillful investor in the history of investing? Of course not. The biggest obstacle is that the market is never static, and conditions always change. A great investment in the morning could be decimated in the afternoon when management is indicted for an accounting scandal, or a company might announce they'd just lost a major customer.

You also simply may not be as skilled as you think you are at determining the expected value of an investment. You might overlook things that savvier investors would see, causing them to pass on the investment. You might choose to blindly follow the advice of others, taking positions based on what prominent analysts and investing gurus tell you to do.

In many ways, pre-flop play in poker is exactly the same as investing. When we decide to call or raise, we're taking a position in the hand, one that we believe has a good likelihood of producing a profit. We believe that the two cards we hold (plus our ability to play them well) will allow us to show a net profit in excess of what we invest to participate in the hand.

Does that always happen? Of course not. We might wisely and happily invest out entire stack with AA, only to see it lose to 72o when conditions change drastically on the hammerlicious flop of 777. Every session we'll play we will make very smart investments that cost us money, when conditions change.

The converse is true as well. We'll also make poor decisions, like calling a huge raise pre-flop with 97h, and will show a very large profit when the flop is 6h 8h 10h. Poor investment decisions can ultimately be very profitable, just as wise, informed decisions can be costly.

Our goal over time, of course, is to avoid poor decisions, and to continually make wise investments, to put ourselves in the best possible situation to profit, again and again and again. To do that we have to ignore the results and focus on making the best pre-flop decisions that we can, over and over and over. If we do that on a continuous basis, we'll be buying low and selling high more often than we'll be selling at a loss.

The key thing to remember is that until the last card is dealt and the hands are shown, nothing is set in stone. No matter how strong your hand was pre-flop or how far ahead you were on the turn, until your position is liquidated and you're stacking the profits, you've only got a paper gain. You're not "owed" anything until it's finalized, until you've closed out the position. Don't start counting your money until the hand is over (or buy that new Porsche based on the value of your unexercised stock options at work), or fall in love with an investment when the conditions have changed dramatically, and every signal is screaming that your hand is no longer good.


Stop Losses

In the world of equities, stop losses (whether mental or actually keyed in) are tools to keep you from losing your shirt on any one invetsment. You do all of the necessary research and decide to take a position that you believe will appreciate in value. You're aware, though, that not every investment goes up. You're also aware of the fact that from a psychological standpoint, it's easy to get married to an invetsment and to chase losses, remaining invested as the value drops lower and lower, hoping and praying that it'll recover and you'll erase the losses.

To counter that tendency, many investors set a stop loss order. This is a pre-determined point at which your position is automatically sold, at a loss. Its sole purpose is to protect you from losing too much in any one investment, limiting your losses to 10%, 15%, or whatever stop loss you set. It's designed to combat the tendency to hold onto poor investments for too long and to preserve your capital. As long as you preserve the bulk of your capital, you're able to continue to make wise, informed investments which will allow you to not only recoup the 10% you lost, but much more.

The parallels to poker are pretty obvious, and don't need much elaborating. It's very tempting to chase losses after a bad session, to jump up to higher stakes, to play more aggressively than you know you should. We've all seen advice to avoid the above behavior yet we've likely all done it, at some point or another.

It's hard to argue that stop-losses are valuable in poker, though. Granted, you need to give yourself enough room to account for normal variance in a session, but preservation of capital (your bankroll) should trump everything else. Tilting and losing a huge chunk of your bankroll is actually more destructive even than it appears on the surface, as the erosion of your working capital will continue to cost you money, each and every day, long after the disastrous tilt session, as it continues to depress your future earnings potential.

In short, love thy bankroll, treat it well, pet it and hug it and call it George, and do everything you can to preserve the bulk of it, even if it means setting arbitrary stop-losses.


Diversify Your Portfolio

Successful investors never put all their money in one stock, and most avoid even putting all of their money in one sector or investment vehicle. The variance can be brutal and your risk is ruin is far too high if you don't diversify.

It's a bit of a stretch, but poker does share some similarities. Your primary investment is going to be your play at the tables, as it's where you the bulk of your capital is going to be employed. While you might argue that you should diversify there, and play LHE, NLHE, Stud, Omaha, Razz, and Triple Draw equally well, in order to play with the fishiest players, wherever they're sitting, I honestly think that's a stretch, as the vast bulk of games are at NLHE/LHE tables.

You can, though, diversify your poker-related income. Rakeback and poker bonuses are obvious ways to accomplish that, as well as hitting up the +EV casino bonuses. Rakeback can definitely ease the blow when things don't go well at the tables, and many of the juicy casino bonuses are simply free money, being extended to you, for very little initial investment of capital.


Invest with a Target

Successful investors almost always have an entry point and an exit point. They don't simply buy stock in a company with the idea of "Der, I hope it goes up and I make mad cash, der". They invest with a target price in mind, at which point (barring material changes), they'll sell and book a profit. That doesn't mean they follow that plan to the letter, due to changing market conditions, just that part of the investment process is picking both an entry and an exit point.

Poker is pretty similar, on both a micro and macro level. Winning poker players think past the immediate decision in front of them, considering the implied odds they're being offered, the inability of a particular opponent to ever release an overpair, and myriad other details. They examine each hand with an eye to present and future value, and, on the fly, determine what they're willing to pay to continue as well as what their price target might be.

You should strive to not only calculate what a good entry price is, but to think past the present strength of your hand and to cast an eye towards just how much value you can extract, based on the board and your opponents. It's not quite enough to say "I'll limp if it's cheap enough and hope I flop huge hand" if you also haven't considered the odds and likelihood of getting paid off, if you hit your hand, and whether the expected profit is worth the risk of calling.

On a macro level, many successful poker players have goals that go beyond "Win lots of money". The goals take many forms (move up in limits, to win X amount of dollars by Y date, to become proficient at a new game, to win a seat into a major tournament), but their purpose are to serve as targets or exit points, so that they can measure and gauge progress. It doesn't mean that you can't be successful simply playing to win money, as some people are, just that many players are more successful when they analyze the situation and set targets.


Chasing Losses

Investors (especially traders) often make this mistake. They lose money on a particular stock and they can't let it go, believing that it somehow "owes" them money, and they continue to take positions in it, largely acting on emotion and not logic. They ignore much more promising potential investments and instead keep forcing themselves back on whatever stock they feel has wronged them. In its worst form, they'll exacerbate the situation by trading much more speculative and risky vehicles such as options, determined to get back all of the money they're "owed", but more often than not only succeeding in digging a deeper hole.

Poker players fall prey to this, too, each and every day. They play long past the point where they're bringing their A game, trying to get unstuck, often targeting a specific player who has been sucking out on them and "owes" them money. They take more and more risks, letting the desire to get back to even overwhelm the smart, savvy decisions that they'd normally make.

Once you've lost capital and closed out a position (or mucked your losing hand), it's gone. It's no longer yours. You have absolutely no claim to it. All you can do is to move on to the next investment or hand and to put the past behind you, as you have absolutely no claim to the lost capital. Use your remaining capital to recoup your loss, by making wise investment decisions. If you're not in the frame of mind to accomplish that, wait until you are.

6 comments:

kurokitty said...

Good advice, but one thing missing from this relates to bankroll -- investors are warned never to invest anything they can't afford to lose and similarly in poker, players should always be playing within their bankroll.

ToddCommish said...

I've consistently advocated getting in on the ground level of the poker stock game by diversifying into the HORSE, Stud, and (two years ago) Omaha. You'll be ahead of the curve in each of the "new" games.

Naturally, for raw numbers, you'll see more "day-traders" in the NLHE rooms, but as a percentage, you'll probably catch more speculators in the esoteric rooms. Remember, there are also many more sharks in the NLHE rooms, and your EV goes down for every shark in the room, so that needs to be priced in.

kurokitty said...

Greg Raymer has said he plays O8 because of all the people who don't know what they're doing in the game...

StB said...

Lots of parallels between poker and investing. Many trading desks have traders learn poker to help with their trading activities.


Well said.

Victor_Enriq said...

Very good point. I see now why so many people read your blog, but I still cant understand why I (after using your casino, blackjack, and other guides often) dont!

This is, certainly, a leak in my game!

FatBaldGuy said...

Nicely said. Nothing really new, but taking concepts like that and restating them in a fresh and understandable way really helps people to grasp them a little better. Thanks.