Investing = Endless Poker
On Poker Investing
Drawing parallels with difficult to understand concepts is always helpful to simplify things and make them easier to grasp.
One such parallel that I would like to draw is the similarities of stock market investing to an endless game of poker.
What do I mean endless? Cards keep on dropping on the table. As long as a company exists and is trading on the stock market, cards keep dropping on the table.
In real poker you can’t pull out your money. When you’ve made a bet you are committed. Newer cards could make you completely change your mind because you don’t feel as strong now. But your money is stuck in the pot. If you fold your cards, you lose your money.
In investing you can pull your money out at any point. You can change your mind, sell your shares and get your capital back. But you can only sell your shares at the price the market is willing to pay for them.
If you are committed it’s because of you and your psychological makeup. Not because of the rules of the game.
This often happens when people won’t sell just because they are in the red. They can’t take a loss even if it makes sense.
Heck, some won’t sell just because they are in the green either. They feel confident now and just want to see profits increase.
But it shouldn’t be that way. At least if you are looking to optimise your returns.
The red or green of your positions has nothing to do with the right or wrong of your positions - only with your mental game. But people tend to mix it up.
This is a game
Poker and investing are both games. In each game there are rules, and you have to know them off by heart to succeed.
But there are smaller games being played around those games. They are smaller but just as important. Your mental game is one of them, and your competition is another.
Sometimes you may have the best cards, but the game gets you to fold.
The other player acts all confident, you feel that his cards are better than yours. He is bluffing and is more skilled in it than you. You fold. You convince yourself that if he looks so confident he must be winning! That’s how the game is played, it’s about winning not just holding the better cards.
Well the same happens in investing. You know what you own and you feel positive about the long term potential of your holdings. You feel good about yourself. Then out of nowhere the market starts to crash.
The drop in prices affects sentiment and people start to get scared. The negative environment gets to you and you start to have second thoughts.
You believe them and you are faked out. You don’t have the required mental fortitude and you sell. The market is dropping - you MUST be wrong.
The market is trying to bully you and make you sell your holdings on the cheap.
But it doesn’t have to be this way. In both instances explained above, the poker game where you fold and in investing where you dump your shares in the crash. The game wasn’t over. You could’ve still won.
For example in poker - the cards that you hold, the cards on the table, and the cards that you think your opponents hold all together equal to the possible expected scenaria.
It’s the same in investing. The future of the business (i.e value), and the stock market value of the company (i.e. price) give you the expected return for that investment. Both price and value fluctuate, and you have to assess the changing expected returns when they do.
If the value of a business has been materially impaired, then it may be time to sell your stock and move on to to the next opportunity. On the flip side, there are times when prices crash but long-term value is not materially impaired.
That’s the time to call the market’s bluff and go all in by buying the shares that your competition is dumping on the market.
In a poker game, all in means you bet all your chips. In investing, depending on your strategy, that means putting a big part of your assets on one bet. Say 30% of your capital.
To play games well you have to know the rules, you have to have a solid strategy and you have to execute that strategy through trying times to come out ahead.
In poker my favourite strategy is tight-aggressive. In investing it’s to aggressively buy good companies when they are selling at a sufficient discount to value.
Besides having a solid strategy, you have to be experienced enough to tweak your strategy as the times and the environment changes. That’s what makes a good player.
When someone is trying to bluff you and make you fold your cards so he can get your money. What should you do?
You gather information from the poker table to pick your next move. What kind of players am I playing against and what do they seem to be up to?
You can prepare and lay out a game plan for what you will do in each scenario.
The bluff in investing is when a stock sells off for unreasonable reasons, resulting in a price lower than value. This could be due to general stock market specific reasons or company-specific reasons. You start to second guess yourself. Maybe I was wrong, you ponder.
Everyone is selling, I am getting ruined by the day. The crowd together with the media jumps in to kill your psychology. This might happen the other might happen. The price of the stock affects your narrative for the company. And when that happens things get crazy.
The thing is, you have to know what you own, just like poker where you have to know what cards you are holding. If you know what you own, you are free to change your own mind.
When you are a weak hand, you fold from peer pressure and lack of confidence.
Investing is not easy.
“It’s not the research that makes the money, it’s what you do with it.”
“I've always said, the key organ here isn't the brain, it's the stomach.”
“I think you’re trying to bully me, and a bully is devastated when you stand up to him.”
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