Poker Player = Smart Investor OR Smart Investor = Poker Player

The other day a friend was going through my book case and came across the bestseller Liar’s Poker, a piece of immense frolic. In a wickedly funny way, Michael Lewis elaborates on his escapades as a rookie trader at Salomon Brothers. My friend wanted to know if the book was about the game poker. Not so, but was surprised to be told that poker is Wall Street’s favourite pastime.

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Think about it. Poker demands immediate exploiting or discarding. Cutthroat decisions to tear down your opponent at every turn of the card. The players have to make instant decisions where one does not have complete information since all the opponents’ cards are face down. Moves have to be made in an environment plagued by unknown variables and imperfect information. 

While I doubt there is a question on the parallels, there could be a slight disagreement on whether traders make great poker players or good poker players make good traders. Steve Cohen, probably one of the world’s most famous hedge fund managers known for his voracious appetite for art, sprawling mansion and prodigious compensation, says poker taught him how to take risks. And that he has taken. He is currently under investigation for federal insider trading charges. 

Carl Icahn (Icahn Partners) now in the news for his tussle with Dell, got mentioned in TIME magazine in 2005 while playing with professionals at the Bellagio in Las Vegas:

In a $40,000 game, he wound up as one of two players left in a hand of seven-card stud. Icahn had two pairs; his opponent was showing four to a straight. The pro tipped off Icahn that he had seen his cards and said that because Icahn was an amateur, he felt obliged to tell him so. The pro then bet the table max: $4,000. Icahn, who had been about to fold, announced to the table, "I learned a long time ago that in big business and big poker, there ain't no nice guys," and matched the bet. His two pairs prevailed.

A few years ago, he wrestled with Texas banker Andrew Beal when both wanted control over Trump Entertainment Resorts. What was not common knowledge was that Beal, a math whiz, dropped out of college to play poker. His winnings were the seed capital in setting up Beal Bank. Icahn once said of Andy Beal, “I always thought of myself as a good player, but I'm not in his league.”

"Poker is a trader's game. Roulette and blackjack are based more on luck,” says Scott Redler, cofounder of T3, a Manhattan-based day trading firm. “But with a game like No Limit Texas Hold 'Em, you need patience and discipline, or in other words the exact same skills needed to be a good trader."

A few years ago, LA Times reported on how trading desks and firms are looking for

candidates who are good poker players and inculcate the principles of the card game in their training programme. The logic? They need individuals who are quick-thinking, decision makers under uncertainty, have nerves of steel and a head for numbers — the very skills that lead to success in poker. A few years ago Toro Trading made news for hiring Chris Fargis who made a name (and a tidy sum of money) in the online poker circuit.

Some economists decided to dig deeper.

University of Chicago economics professors Steven Levitt (author of Freakonomics) and Thomas Miles attempted to get to the heart of the debate on whether poker is a game of skill or luck. True to their profession, they dug into data (made available by the 2010 World Series of Poker) to come up with a conclusion. The results were published a working paper titled entitled The Role of Skill Versus Luck in Poker: Evidence From the World Series of Poker.

The duo found significant evidence that poker is not a game of luck, but rather, a test of skill. Players assumed to be skilled earned 30% on their investment, compared to all other players, who lost 15%. To put that in perspective, Levitt and Miles compared the return on a poker investment with that common from the financial markets. The conclusion implied that if you are a very skilled player, your money has a better chance of growing at a poker tournament than on Wall Street (which has fund management fees to cater to).

So what are the skills that you can learn from professional poker players that can be applied to investing?

• Don’t get too big for your boots.

• Don’t try to be more intelligent, just less stupid.

• Have a plan. Stick to it. 

• Identify a strategy and don't drift.

• Control your emotions.

Vanessa Rousso, nicknamed Lady Maverick, is easy on the eyes but hard on the wallets of

her opponents. This poker pro holds a degree in economics and has a penchant for games of strategy like backgammon and chess. She cautions against overconfidence which she claims tends to come in after particularly large gains. “In tournaments when I’ve won a series of hands, it tends to make me loosen up and take excessive risks. What could have been a period of prolonged success is quickly shortened by overconfidence.”

Her solution in combating overconfidence? By recognizing when you’re deviating from your game plan.

That’s good advice for investors, too. When you’re tempted to take more risk, recognize the effects of overconfidence and methodically think through your plan. Overconfidence could lead to big losses. Don’t go overboard in a bull run and shift huge chunks of your portfolio into equity. Or, if a type of fund is doing well such as a mid cap or an international one, don't increase exposure indiscriminately to it. When the bubble bursts, so will your fortunes. 

The problem is that most humans, as investors or poker players, like to consider themselves rational and are prone to becoming overconfident. Jason Zweig points out in his book Your Money & Your Brain, about 75% of people will judge themselves better than average at anything -- from driving to basketball to telling jokes to scoring well on an IQ test. Of course, half of any group, by definition, must be below average.

Most poker players believe they are fully capable of making sensible table decisions based on their knowledge of the game combined with a basic understanding of the laws of probability. But if this were really true, there would be no losing poker players. All poker games need players who think irrationally, exercise poor judgment, and lack discipline. And you are stupid if you think that it cannot be you. Warren Buffett says it well. "If you've been playing poker for half an hour and you still don't know who the patsy is, you're the patsy."

Hedge fund manager Ray Dalio says that investing bets, like poker, are a zero-sum game. The nature of investing is that a very small percentage of the people take money (essentially, in that poker game) away from other people who don't know when prices go up whether that means it's a good investment or if it's a more expensive investment. It is very important for most people to know when not to make a bet, because if you're going to come to the poker table, you're going to have to beat me, and you're going to have to beat those who take money.

How does he counter that in investing? We spend hundreds of millions of dollars on research and we don't know that we're going to win. So we have to have a lot of diversified bets.

Poker players differ from each other in strategy. 

Chris Ferguson, an ex-trader at a prop trading firm, holds a PhD in Computer Science and has an advanced understanding of poker mathematics and game theory. His knowledge compensated for his lack of experience when he won the World Series Main Event in 2000. Gus Hansen, on the other hand, is said to be more “feel-based” and once said that he takes risks that no-one else would take, but if he thinks those risks are justified then there’s no reason for him to back down.

Hedge fund manager David Einhorn gave a speech in 2006 on the strategies of different poker players.

• Loose aggressive types play lots of hands – virtually any two cards – and try to win lots of small pots. They are the day traders of the poker tables.

• Others play any Ace or any King or any two high cards. They play too many hands, but don’t play them well. These folks can do fine for a while, but get outplayed after the flop by the loose aggressive types who eventually wear them down so that they wind up in a 1 of 11 desperate spot playing a decent hand against a strong hand for the remainder of their chips. I would compare them to long-only closet indexers who trade too much.

• Then there are the rocks. These folks sit around waiting for premium hands – high pocket pairs or an Ace, King. They fold and they fold and they fold. They are going to wait until they know they have a huge advantage. Then they bet as much as they can. It is very hard to beat a player like this. They can last a long time. Once people figure them out, nobody will play them when they do play. So they don’t get the chance to get enough chips in when they have a large advantage. Could this be what is becoming of Berkshire Hathaway?

Incidentally, Buffett too tries his hand at the game, though much more skilled at bridge. He once confessed that he does not care about poker as much as bridge. Not surprising when you take into account his buy-and-hold temperament as against a trader’s mentality. 

Investors, like poker players, must stick to their own game plan– what to invest and how to diversify based on their strengths and comfort levels and strategy. There will be bad patches. There will be certain investments that will not deliver. Everyone is bound to lose money sometime. But don’t pull out in haste when the market crashes and hide your money under the mattress. Stick to your strategy with your eye on the long term.

Losing a big hand in poker hurts, a lot. And when that happens, players lose focus and start to play more risky or avoid betting altogether, either way they are hurting themselves.

Keep the big picture in mind. It's not the individual hand or investment that matters, it's the game. You can lose a big hand every now and then as long as you have all the chips at the end.

Most importantly, keep the emotions under control. The biggest mistakes are made when you let them get the better of you. Daniel Negreanu, one of the world's best poker players has said that "having emotional stability and emotional control is key to both investing and poker." According to the Chicago Tribune, success at investing and gambling has much to do with controlling emotions. This is because the psychological issues that drive them both are identical. 

I guess I can end with a quote from hedge fund manager Daniel Shak: "The skill set you need to succeed in corporate life and the financial world is the same skill set you  need to succeed at the poker table".

 Most of the above tips have been sourced from Kiplinger, US News Money, Business Insider, FSP Invest.