OK, so the title of this post is a bit of an exaggeration and yes, there are probably tons of better poker books out there now post-extended-poker-boom. The first edition of this book was published in 1978. The connection between poker and trading is nothing new. Just google "poker and trading" and there's a lot of stuff out there; how poker guys started hedge funds, how a hedge fund guy became a poker guy, how they are similar/different, what can be learned from one or the other etc. And the connection between gambling and trading was well documented in Fortune's Formula.
But I just wanted to make a post about this book because I'm starting to reread it again (don't ask). I am not a poker player, but I remember reading this book a few years ago having borrowed it from a poker-playing friend. Knowing that many traders and investors are very good poker players, I wanted to see what I can learn from reading about poker.
I remember falling out of my chair at the similiarites between poker and investing. I come from more of a trading background than an investing one and what was written in this book, particularly the early chapter "General Poker Strategy", has great advice that applies to traders and investors too. I would make that chapter required reading along with the other investment "must reads".
Anyway, here are some comments about what Brunson talks about in this chapter by sections. I only comment on some of the stuff so this isn't a summary of the chapter by any means.
Pay Attention... and it will pay you
Here Brunson talks about paying attention to other players during a poker game. Watch and listen carefully even if you are not playing for the pot and you will pick things up.
He also suggests bluffing to see what someone does to learn more about him. We might think we can't do that in the markets, but bigger hedge fund managers actually do test the market. They can try to buy a big lot of bonds or sell it to get a sense of where the weakness might be; they are probing the path of least resistance. But most of us can't do that, and long term investors would have no interest in such market operations.
But the advice, to pay attention, is applicable to all of us in the markets. We have to pay attention to what's going on in the market. We always like to say, ignore Mr. Market, or ignore the macro, but we have to pay attention to what's going on. Maybe if I paid more attention, I would have bought some Liberty Media in late 2008. OK, enough of that. Get over it.
But it's true. We have to pay attention. There might be a tendency, when we own positions we are happy with to get lazy and ride it out. But then what do you do when things get to fair value or above? Or there might be better things out there even if we are happy with what we own.
So we must pay attention.
Brunson also says, "A man's true feelings come out in a Poker game". He says you'll learn a lot about a person's temperament by watching a ballgame he has bet a lot of money on; how well he can take disappointment etc. He says it's the same in poker, and it's the same in trading and investing too.
Talk to people at the height of a bull market or at the lows of a bear market and you will really know what kind of temperament the person has. I'm sure all of us with professional experience have anecdotes about traders and investors on their big up and down days. I tend to trust the guys where you talk to them on any given day and you have no idea if they are up or down on the day. The ones you can tell from across the room are the ones I would tend not to trust... (well, there are overly emotional, screaming/yelling, phone-breaking-monitor-throwing great traders, and then the quiet people who just blow up with no early signs, I suppose but...)
You can really learn a lot about yourself, too. You can't really observe other people in the investing world, so you can just observe yourself and learn a lot about yourself and who you really are and what you might or might not be cut out for.
Play Aggressively It's the Winning Way
Here he talks about the difference between a "tight" player and a "solid" player and how many people seem to be confused about it. In poker, a tight player is a conservative one and won't play too many hands. A "loose" player is the opposite; like a drunk player that plays every hand, calls every bet. But a "solid" player is not the same as a "tight" player. A "tight" player is a conservative player that will play tight all the time, but a solid player will play tight, but when he plays, he will play aggressively.
There is "tight" and "loose" in investing too. We've all met someone who will buy almost any stock on any tip (loose), and others who won't buy anything, or will rarely buy anything. When I first started investing for myself, I was very tight too. I read a few Buffett books and figured, OK, I'll just by Coke in the next bear market at 8x P/E. It's a great idea, but the only problem is, Coke doesn't get to 8x P/E, ever (and when it does, you may not want to own it!).
I just figured if I had a Buffett-like stock (high ROE, high-moat business) and bought it for really cheap, I can't lose. Well, this is correct in theory, but that's like wanting to wait for a royal flush before ever betting. It didn't take me long to realize that this approach won't work.
Now I like to see myself as a "solid" investor.
I would put people like Buffett, Greenblatt, and any of the great traders/investors as "solid". They will pick their shots and not play too many hands, but when a good hand comes along, they will go in big.
Brunson says, "Timid players don't win in high-stakes Poker". This is true in the markets too. But that doesn't mean you have to be "loose" or that you should ignore risk.
I think there are a lot of smart and competent investors and traders that don't do well because they don't have this sort of killer instinct. They are way too timid. They love a stock and they have 2% of their AUM in that stock, for example. I read a decent book on investing not too long ago and was impressed, but when I looked at the author's portfolio (no names!), it looked more or less like an index. There is no way this portfolio is going to outperform the index by more than a percent or two with that sort of diversification in the largest cap stocks. (Yes, Peter Lynch and others have been known to have a large number of names in their portfolios but my impression is that those portfolios contained smaller and midcap names, not the largest companies. This is why they were able to outperform despite the high degree of diversification).
We know how focused Buffett is (and was during the partnership years), and many of the other great investors/traders.
I remember talking about Soros once and someone who was close to him said something to the effect that Soros is not that different in terms of analyzing markets and finding trade ideas than others, but he had the ability to put on huge size. In other words, he was no smarter than anyone else, but he had the biggest balls (more on courage later).
And the great thing about the markets is that the markets can't fold on you. If you go "all in" in a poker game, you might scare people away. But not in the markets.
Art and Science: Playing Great Poker Takes Both
Brunson says poker is more art than science, and that's why it's difficult. Knowing what to do, the science, he says is 10% of the game, and the art (knowing how to do it) is 90%. He says in the introduction that a computer can be programmed to play blackjack well, but not poker (even though I hear that bots win a lot of money playing poker online these days).
It's similar to the world of investing/trading. People have used computers for years to create trading models, and many of them do make money. But the models are programmed by humans, reprogrammed, recalibrated, adjusted etc. according to market conditions. I don't think there is a self-learning/improving computer trader/investor out there (yet).
In this section, there's an interesting comment:
"Any time you extend your bankroll so far that if you lost, it would really distress you, you probably will lose. It's tough to play your best under that much pressure."
This is exactly what Joel Greenblatt said in an essay soon after the financial crisis. He was talking about how many people thought the error in their investment was that they didn't foresee the crisis and so didn't sell stocks before the collapse. Greenblatt insisted that this couldn't be done anyway and that the real error was that these people simply owned too much stocks. If you own so much stock that a 50% decline is going to scare you and make you sell out at precisely the wrong moment (and as Greenblatt says, and Brunson says in this book, you are almost guaranteed to sell out at the bottom), then you owned too much stock to begin with. Greenblatt said the mistake wasn't that they didn't sell before the crisis, but that they sold in panic at the bottom. This was the error.
So the key defense against inevitable (and unpredictable) bear markets is to not extend yourself so much that it will distress you when the markets do fall (and they will). Buffett says that if it would upset you if a stock you bought declined by 50%, then you simply shouldn't be investing in stocks. As I like to say all the time, more money is probably lost every year in trying to avoid losing money in the stock market than actual losses in the stock market!
Brunson also suggests thinking about chips as units and not as money. This is so very true in trading and investing too. If you think about money as money, then it may impact the way you invest. If you think of a loss as real money, it might upset you. For example, if a stock tanked and you lost money on it, it's easy to think, "gee, I could've bought a Porsche with that money...". Or if a loss is thought of as next month's rent, you won't be able to focus on the process; you will be distracted by the reality of the money.
Courage: The Heart of the Matter
Brunson says, "I'm asking you to walk a very thin line between wisdom and courage, and keep a tight rein on both". He says that courage is "one of the outstanding characteristics of a really top player". He points out that some people play really badly after losing a big pot while others play much harder.
He says that one of the elements of courage is realizing that money you already bet is no longer yours regardless of how much you put in. This is similar to investing where people do tend to get caught up in their cost (I'll get out when it gets back to break even, etc...). If it doesn't make sense to call, then one shouldn't call. People probably tend to look at what they put in the pot and they might call not wanting to lose what they already bet. Similarly in a stock, if you buy something and it's no longer a good idea, it's not good to wait for break even or even buy more just to get the average cost down so you can break even sooner.
As I said in the above about being aggressive, I think that one of the big differences between OK investors/traders and great ones is courage, or balls (is this appropriate blog language? I don't know).
But Brunson, in the section on being aggressive, distinguishes between being aggressive and being stupid. He sites an example of a player trying to bluff someone out of his money with a losing hand, and he calls that stupid, not aggressive.
There is sometimes a fine line, maybe, between stupid and aggressive in the investing world too. I'm sure to insurance company executives (in charge of investments), Buffett's backing up the truck on American Express during the salad oil scandal might have looked stupid or reckless at best.
There is a tendency to assume that "diversified" equals "safe" and "focused" equals "risky", just as there is a misconception that "beta" (or stock price volatility) equals "risk". This is not true at all. As Howard Marks says in his great book, The Most Important Thing, risk is not a function of these things. Overpaying for high quality companies can sometimes be riskier than paying a very low price for a mediocre company etc.
The Important Twins of Poker - Patience and Staying Power
This is very obvious too in the world of trading and investing. You have to have patience. Ian Cummings at the last LUK annual meeting (in 2012) put it like this: You should sit on a porch, watch the world go by and then if you see something succulent, jump on it.
Buffett talks about his 10-hole punch card, or waiting for the perfect pitch (there are no strikes in investing. There are no antes either so it doesn't cost you anything to fold right away).
Brunson talks about not drinking here; hopefully nobody reading this makes investment decisions while drinking.
There are a few other pieces of good advice (look for weaknesses in your play and fix them etc...) but an interesting point here he says,
"Maintaining confidence is your strongest defense against 'going bad'. When you start to go bad or just start to think you're going bad, you become hesitant... Allowing your confidence to be shaken can turn a simple losing streak into a terrible case of going bad".
This is very interesting because watching value investors during the crisis, it feels like a lot of people lost confidence. One investor who was a focused investor decided to diversify more after taking big losses only to go back to a focused approach after the markets recovered.
Many other value investors seemed to question the idea of value investing itself and sound these days more like macro investors. Many seem to have lost their faith in the stock market overall.
Controlling Your Emotions
Brunson advises, "never play when you're upset". We all know that the biggest detriment to successful investing is our own emotions. But I saw it over and over again during the crisis; people throwing in the towel at the worst possible moment because they lose faith. Too many 'bad' bankers and corrupt politicians etc. It sounded like people were selling stock not only out of fear, but out of anger. Brunson would tell these people, "don't make investment decisions when you're upset!".
The Other Similarity
There are many similarities and I don't intend to list them all up, but the other thing that struck me about poker and investing (and this is not from the Brunson book) is that in both, there are two types of participants;
- perpetual loser
- improving / studying winner
This is similar to what people say about poker players. Many of them do no work to improve, but they take pride in their wins, and when they lose, it was just bad luck.
Both poker and investing have enough of an element of luck for people to keep fooling themselves in this way (nobody would lose a chess game and say it was bad luck, for example). And there is enough element of luck such that people will tend to win every now and then with no preparation, and this gives them enough to sustain their 'hope'. And this is what they lean on, not any serious work.
And there's enough luck involved that many believe that it's all luck (efficient market folks thinks it's impossible to beat the market etc...). So therefore there is no attempt by these folks to work on their game.
And this is why it's possible to win; this is why the pros constantly walk away with the money, whether at the poker table or the stock market.
Anyway, none of this stuff is new to experienced traders and investors (and of course poker-playing traders/investors).
But I wanted to highlight some of the things that really struck me (actually, it struck me the first time I read it a few years ago, but...). Also, it's interesting to look at what we do through sort of a different lense. Am I playing too tight? Too loose? Am I being aggressive enough? Am I really a solid player or just tight? Or am I being timid?
Looking at your portfolio this way may tell you a lot about yourself and may even suggest ways to improve your investment performance.
This is really good stuff kk. Perhaps you should offer to ghostwrite Seth Klarman's sequel :)ReplyDelete
Side note -- I was watching a video of Klarman giving a lecture to the Columbia GSB students a few years ago and he jokingly said the title of his follow-up will be, _The Safety of Margin_
Thanks for the comment. Yeah, a Klarman sequel would be awesome. I would love that. But as he seems to always say, he has other priorities... He doesn't even want to spend the time to get MOS republished (because he would probably want to update/revise it).Delete
Thanks for reading.
There is a tension between being "solid", which requires boldness, and not overextending one's bankroll. You mentioned Soros. I don't think it's that simple to just "have balls". Soros had the balls at the right time.ReplyDelete
The way I see it, it all comes down to applying Kelly's consistently, sizing the stakes correctly, with the right facts and right reasoning.
I would say Soros does possess skills. Maybe not in analysis, but in capital allocation (or position sizing), the most important job of an investor according to Munger.
Another thing is, Greenblatt's comment about investors selling at the worst time at the height of the crisis doesn't paint the complete picture. I believe a lot of the smart professional investors sold out only because their clients chickened out and withdrew their money. They were forced sellers.
That said, great post. As you said, nothing is new here. But it's a bit like reading Horward Marks "The Most Important Things". Nothing is new. Yet it serves well as a reminder when one is lost once in a while.
p.s. You mentioned great books. I found Taleb's Antifragile brilliant. I put it in my must-read collection. He puts forth a philosophical framework based on a single idea. The risk management approaches employed by virtually all great investors (Buffett, Munger, Greenbatt, etc.) can be distilled down to Taleb's idea of antifragility. (In one sense, antifragility is a meta-philosophy.) Sadly many people can't stand his arrogance and his obsession to view and interpret anything under the sun with a probabilistic and risk management tilt.
Yes, there is more to Soros than just having balls, but I think, including one of the great traders that I used to work for, the one big feature was their balls. When you sit and listen to them speak or talk to them, they don't often have much to say that differs than many other participants in the market. They are not a Mike Burry-type, seeing things others don't see. It's a combination of two things, basically; the ability to go in big when they see an opportunity (like Buffett/Munger) PLUS the ability to know when they are wrong and get out.
If you have followed Soros over the years, he's made some spectacular calls (British Pound etc), but also some horrible ones. But he still makes money. That's the way it was with the supertrader I worked for. People always wondered, boy, he's so wrong in his forecasts, how does he make money? Because he can go in huge long and be short the next. Not many people have that ability to admit that they are wrong and get out or ever reverse the position.
Maybe this will be a post topic one day, but that would be more of a trading oriented post and I don't really do much and thing much about trading anymore so...
And yes, many funds had to sell to meet redemptions so it's not the fund managers' fault in many cases. But I think Greenblatt was directing his comment to the general public / individual investors. Equity fund managers are supposed to be fully invested in equities as a mandate, so it's hard to apply his comment to a mutual fund manager.
(This was too long so I have to cut my response into pieces... so more to follow below)
Also, yes, I have read Taleb's other books and I actually do have a problem with them. Maybe that's a whole other post (but I wouldn't write a post just dissing someone's book, lol...). Ironically, my favorite book of his was the one he wrote, Dynamic Hedging, about hedging options positions.Delete
The problem I have with Taleb, in a nutshell, is that he uses the normal distribution thing to ridicule wall street, but the fact is that it has been known widely since at least 1987 (black monday) that the stock market isn't normally distributed, and anyone who has actually traded individual stocks before knows that it is not normally distributed, and especially option traders.
If you look at volatility smiles/skews or whatever you want to call them before 1987, I think they were flattish, but after black monday, they have become highly skewed; out-of-the-money strike price options have much higher implied volatilities than the at-the-money options.
This is the market manifestation of the non-normal distribution expected by market participants. If option traders believed the markets were normally distributed, this would not be the case.
So all of that talk ridiculing wall street to me sounds a lot more like a straw man argument. I have managed small books and spent most of my career on a trading desk, and I don't know anyone who thought markets were normally distributed.
But yes, the BS and other models used that distribution and it was because it was a good estimator of near term market movements (even Buffett says that B-S models are good estimators over the short term).
Also, the notion that people didn't really expect the unexpected is also a bit of a straw man argument. Taleb says these people on Wall Street are stupid because they believe in this normal distribution. (I would argue that the losses were not due to the 'shape' of the distribution; using a more accurate shape would not have prevented a lot of the problems on the street. Many even used monte-carlo which I think Taleb advocated, which doesn't assume any distribution but uses the actual price history and real distribution. Many monte-carlo models have blown firms up too (my firm blew a giant hole in the balance sheet once with a mortgage book and that was mostly a monte-carlo-type simulation model, I think).
I thought about this and I disagreed with the "Wall Street is stupid" argument. If that were true, there wouldn't be so many rich wall street people.
When someone levers up as a trader and blows up, it's not because he believed in a normal distribution. It's because he thought, if the market didn't tank, he will walk home with 10% of the profits. If the market tanked and he blew up, he would walk away and pay back nothing.
In other words, the traders were exercising their traders' options.
They were behaving perfectly rationally. They are not stupid. If you think the market will blow up every five years, you can still lever up and trade and try to make money four years out of five. This is still a very rational thing to do.
But Taleb doesn't talk about any of that and just makes it look like peole on the street just have no clue. And this is really not quite an accurate representation of what really goes on.
Anyway, I can go on and on, but that's my feeling.
Thanks for reading!
Oh, and a further thought. Taleb and many others keep criticizing VAR as a risk management tool, and they are correct to do so. But many critics make it sound like banks only use VAR and nothing else, and that's why they blow up or some such. This is very far from the truth.Delete
Dimon was getting beat up for VAR issues with the whale loss too, but the fact is that Dimon has said over and over over the years that he is not a big fan of VAR.
I have worked with VAR models and tracked expected losses versus actual losses. The fact is that VAR is an uncannily accurate estimator of portfolio variance MOST OF THE TIME. So it's not entirely worthless. It's just deeply flawed, and people know it. We knew it at least going back to the 1990s (and I wasn't at a cutting edge firm by any means!).
We knew that if something bad happened, correlations would go to 1.0 and all your positions would tend to go against you. We learned some of that in 1997/98 during the LTCM crisis and the Asian contagion.
So that was known long ago too, and there were other metrics used track risk including many iterations of a stress tests. Derivatives traders hated stress tests, of course. If you are an equity options premium writer, your book tends to look bad in a stress test that simulates a 10% or 20% decline in the stock market, lol...
All of these issues were out there and risk management looks at a lot of stuff, and this goes back to the 1990s, at least.
Yes, mistakes were made, and they will be made in the future. Banks will blow up and we will have near-depressions again. Kindleberger showed us that this has been true throughout history. So to place all the blame on some assumption about normal distribution or VAR is overly simplistic.
Very interesting comments on Taleb.Delete
I don't think he advocates monte-carlo models. He advocates not to model them at all because if a model is only accurate most of the the time, it means the underlying system is unmodellable and will blowup sooner or later. To a trader/investor, it means putting these in the too hard basket and not to take a position at all. This mirrors Buffett/Munger's attitude. But this is something Wall Street can't do because everyone there has a mandate to grow revenues.
I've only read Fooled by Randomness and Antifragile. Maybe he's said something else somewhere. I dunno. And I'm not sophisticated enough to read Dynamic Hedging. The maths fries my brain...
I do admit I'm an outsider. I'm writing all these from my impression.
Can you make a Twitter account that tweets links to your blog posts? I don't use RSS and it would be a much easier way to follow your blog.ReplyDelete
I don't plan on using Twitter any time soon, but I'll keep it in mind.
Thanks for the idea.
I think it can be automated so that when you make a post it will automatically be tweeted out. A quick google search found this http://twitterfeed.com/Delete
Thanks for the tip... I'll take a look at it later.Delete
very good article. I wrote a blog post on sept 2011 titled value investing, stop losses and the truth. It was my contribution towards the discussion of stop losses among value investors.ReplyDelete
"Brunson talks about not drinking here; hopefully nobody reading this makes investment decisions while drinking."ReplyDelete
This must be where I have been going wrong!
Very nice post!ReplyDelete
Some further random observations I find noteworthy (among many more):
- investing returns have a positive skew (market return), poker returns have a negative skew (rake)
- related to the above, you can make money as a passive investor, but not as a passive poker player
- in poker it is reasonable to sustainably make 100% annualized return on your bankroll (for smaller bankrolls), in investing not so
- however, investing scales much better than poker (the process of investing 10bn is somewhat comparable to investing 1m, but you can't make a decent return on a 10bn bankroll in poker)
- age seems to act more against poker players than against investors
- as with all other heavily cerebral activities, jewish people are vastly overrepresented (relative to % of population) among the winners in investing and poker
Age isn't good for poker players because most of them don't work enough on improving their game when they get to the top compared to people trying to get there. Online poker players who play 10/20 cash games will play 1 to 1.5 millions hands a year because there's still a lot of volume and liquidity at these stakes. Players who get to let's say 50/100 and above will often play at a rate of 200k hands a year so it's harder for them to get better.Delete
Your numbers can't be right. If I play 1 million hands a year / 365 days / 24 hours = 114 hands per hour / 60 minutes = ~2 hands per minute all day every day.Delete
After a google search I realize people can play up to 24 hands at a time. What a waste of human potential.
The thing I find really hard is even if you know this stuff, doing it still so hard. Do you have any advice on how be a better doer? Sometimes you fool yourself with how much you know so you are actually a loose player, and other times you know you don't know too much and you end up being too tight. Its a difficult balance. Compared to poker you can play without real money but still gets the high and low of busting other guys or be busted yourself, so you can get enough feedback to get better. There is no good simulations for investing that would allow you to feel the pain of losing money on bad stocks or the pleasure of being right over the market. I think thats why its so much better when you start investing when you are young so that you are playing with small amount of money but it means a lot to you.ReplyDelete
It is hard and I don't know an answer that is right for everybody, but one thing I would suggest is just to start small. I do think you should do it with real money because simulations just aren't the same.
But start small enough that it is not too upsetting if you buy stocks and it goes down a lot. And then just go from there.
Seeing p/l swings can take time to get adjusted to. I remember sweating a dollar loss that now could happen in minutes and wouldn't bother me, lol...
But yes, balancing tight/loose etc... and many other conflicts is tough.
you can trade less than 100 shares if you want to. maybe not on etf's, but on individual stocks. i'v done it in the past. i'm pretty sure you can still do it. so you can play Real Small if you want to.
I'm in a similar situation as yourself and am still learning. I'm in my mid-20s so I didn't even really have much capital to invest until recently. One thing I would stress is that even if you're starting small and are only investing a few hundred dollars across several positions, DO NOT treat it as chump change - you must approach this as if you were investing a much larger amount. I have way too many friends that are starting to "invest" when they're stupidly speculating, instead of trading or investing with a clear framework in mind with the plan to "start investing" when they have a bigger capital base to work with. It's not easy especially when you feel like even if you identify a great stock you only will make a few hundred, but taking the longer-term view is what will set you apart from others in 5, 10, 15+ years.
Really enjoyed your post
I have summarized it in my own words and posted in my blog
Hope you dont mind
I consider my self as a beginner value investor (started in 2010). I have a day job so progress is relatively slow.
Anyway, I discovered your blog just recently and I love it!
Thank you very much for sharing the information with the world and in such a clear, smart and practical way!
Yoav (from Tel Aviv)
Thank you for the article.ReplyDelete
Are there any other investment books you consider must read?
(Apart from the obvious list, the intelligent investor, security analysis, the most important thing...)
Hi, thanks for reading. I did set up a bookstore on Amazon for this purpose... It may not be complete as I haven't updated it, but a lot of books I like are in there:ReplyDelete
Or you can just click the Brooklyn Investor bookstore button somewhere at the bottom of the blog...Delete
Nice blog and attractive information. I like your blog and your work.ReplyDelete
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very much enjoyed your post, in fact I frwded onto some poker and investing friends. I figure some of you might be interested in this conference I'm helping put together that coincides with the WSOP Main Event in Vegas this summer. The site is www.macrosports.co let me know if you have other questions.ReplyDelete
Yes, keep control on emotions. You should also keep faith in you. It’s really a better for success. Cheers for this informative investment book.ReplyDelete
Very interesting insights. You might also enjoy an article I wrote several years ago exploring the differences between gambling and investing: http://www.investorguide.com/article/12525/what-is-the-difference-between-gambling-and-investing/ReplyDelete
You have probably seen it, but just in case you haven't, there is an interview with Stan Druckenmiller and he says "Soros taught me that good money management is all about making a lot of money when you're right, and not losing much when you're wrong.. sometimes you have to go for the jugular"..ReplyDelete
Your blog has given me that thing which I never expect to get from all over the websites. Nice post guys!ReplyDelete
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Thank you for another great post. Post COVID, I am re-reading your blog from the start. What a treasure box.ReplyDelete