Poker and the Beginning Trader
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- Start date
Barron's
Monday, June 28, 2004
Two of a Kind?
With a poker face, Wall Street sees similiarities between a card game and it's own game
by Michael Santoli, Senior Editor
Folks who work on Wall Street love their games. Witness the prevalence of broker-hosted golf outings and trading room betting pools. And, every so often, Wall Streeters' affinity for games converges with their obsession for trying to figure out the stock market, generating a fashionable metaphor for thinking about investing.
It's now one of those times. There's a vogue in investment circles for exploring the world of gambling - particularly poker - in the hunt for insights into investor psychology, good decision-making and sharp risk-reward analysis.
Of course, the language and lore of betting has long been a part of the rhythm of the Street. The terms "ante", "vig" and "house money" have all doubled as shorthand for investment phrases. And both Wall Street and the gambling demimonde tend to attract young men dreaming of easy money. Some rely on their wits; others use complicated computer-driven systems to coax profits from long odds.
But these days - at investment conferences and in market- strategy essays and chats with portfolio managers - a more high-toned, analytical take on the gambling arts and sciences is being aired.
Legg Mason's celebrated fund manager Bill Miller hosted a provocative conference for clients last fall in Las Vegas, where his colleague David Nelson delivered a talk on the ways in which poker is akin to investing (read it at http://www.leggmason.com/billmiller/conference/illustrations/nelson.asp).
Just this month, the Society of Quantitative Analysts held a seminar featuring presentations on sports betting by a finance professor and another on Texas hold 'em poker. The latter was delivered jointly by a Harvard Business School professor and a former professional poker player-turned-options-trader-turned-hedge-fund-manager.
And from conversations with brokers and hedge fund managers lately, it's clear that one of the books making frequent rounds on Wall Street recently is Bringing Down the House, a best-selling account of a scheme by MIT students to win millions at blackjack in the 'Nineties.
No doubt, the general revival of popular interest in gambling culture is part of Wall Street's focus on the betting life these days. The unlikely success of the World Poker Tour on the Travel Channel has been echoed by the hit Celebrity Poker Showdown on the Bravo network. It's no surprise that reality-TV impresario Mark Burnett (the culprit behind Survivor and The Apprentice) has created The Casino, which premiered this month.
James McManus, author of another hot poker-related book, Positively Fifth Street, makes a broad claim in the introduction to the new anthology Read 'Em and Weep. "The case can be made for poker having supplanted baseball as our national pastime," he ventures. "What used to be called 'the cheater's game' is now, for better or worse, at the heart of America's romance with market democracy."
Extending this line of thought a bit, the gambling-oriented books in favor today may qualify as this year's Moneyball, the Michael Lewis book about the "value investing" approach favored by Oakland A's general manager Billy Beane in acquiring baseball players.
Released a year ago, Moneyball was perhaps the most popular non-financial book in years to penetrate the consciousness of professional investors, who eagerly gave it to clients and invoked "Billy Beane-ism" as shorthand for their stock-picking strategy. It got to the point where references to Moneyball in fund managers' annual shareholder letters quickly attained cliche' status.
Moneyball showed that ballplayers were systematically mispriced because of the hidebound attitudes of talent evaluators, the sloppy use of statistics and a misapprehension of what traits contribute to winning. It offered hope to money managers who continued to search for the profitable key to selecting stocks that the market has missed.
Bringing Down the House is a more vicarious pleasure, but one that appeals to Wall Streeters' hope for stumbling on to a "system" that lets them get the better of the competition in a game with the odds arrayed against them.
As if to underscore the common threads, Amazon.com lists Moneyball as the first suggestion among other books as a reader of Bringing Down the House might enjoy. And to complete the loop, the Amazon page for Moneyball refers readers to investor-focused works like Enron post-mortem The Smartest Guys in the Room and Michael Lewis' first book, the men-behaving-manly Wall Street memoir Liars' Poker.
The blackjack-as-stock-trading analogy is a tempting one for investors to seize, mainly because blackjack is a "beatable" game, given enough statistical computing power, strict discipline, a permissive casino boss and sufficient capital to weather the vagaries of hand-by-hand luck.
Market pros also like the comparison because blackjack "is the only casino game of chance whose outcome depends on past outcomes," as John Allen Paulos writes in A Mathematician Plays the Stock Market. That's because each player sees all the cards that have been dealt and then can compute the odds of any unseen card being dealt from the remainder of the deck.
There are other simplifying aspects of blackjack that may draw investors' interest. A player bets only against the house, whose dealer must adhere to rigid rules known by everyone. For instance, the dealer will take another card until he or she has a 17 or better, or has busted by having taken cards that add up to more than 21.
If only the stockmarket were so straightforward.
Sure, investors routinely extrapolate past performance to project future investment results. But everything from academic studies to mutual fund disclaimers exposes the fallacy of relying on the historical record to infer performance down the road. And in the markets, no investor knows, in advance or after the fact, what "rules" are motivating the investor on the other side of the trade.
Justin Wolfers, a Stanford professor who is joining the staff of the Wharton School at the University of Pennsylvania, has shown that legal sports-betting "markets" are mostly as efficient as financial markets. And they're inefficient in some of the same ways, mainly rooted in participants' behavioral biases.
For instance, deep long shots in horse racing are systematically over-bet, meaning that 50-1 shots win far less often than once in 50 times. In the same way, deeply out-of-the-money stock options are routinely priced higher than their theoretical value. This may be due to a 'What the heck" impulse among players, and a human inability to distinguish long odds from truly miniscule odds, says Wolfers.
(continued below)
Monday, June 28, 2004
Two of a Kind?
With a poker face, Wall Street sees similiarities between a card game and it's own game
by Michael Santoli, Senior Editor
Folks who work on Wall Street love their games. Witness the prevalence of broker-hosted golf outings and trading room betting pools. And, every so often, Wall Streeters' affinity for games converges with their obsession for trying to figure out the stock market, generating a fashionable metaphor for thinking about investing.
It's now one of those times. There's a vogue in investment circles for exploring the world of gambling - particularly poker - in the hunt for insights into investor psychology, good decision-making and sharp risk-reward analysis.
Of course, the language and lore of betting has long been a part of the rhythm of the Street. The terms "ante", "vig" and "house money" have all doubled as shorthand for investment phrases. And both Wall Street and the gambling demimonde tend to attract young men dreaming of easy money. Some rely on their wits; others use complicated computer-driven systems to coax profits from long odds.
But these days - at investment conferences and in market- strategy essays and chats with portfolio managers - a more high-toned, analytical take on the gambling arts and sciences is being aired.
Legg Mason's celebrated fund manager Bill Miller hosted a provocative conference for clients last fall in Las Vegas, where his colleague David Nelson delivered a talk on the ways in which poker is akin to investing (read it at http://www.leggmason.com/billmiller/conference/illustrations/nelson.asp).
Just this month, the Society of Quantitative Analysts held a seminar featuring presentations on sports betting by a finance professor and another on Texas hold 'em poker. The latter was delivered jointly by a Harvard Business School professor and a former professional poker player-turned-options-trader-turned-hedge-fund-manager.
And from conversations with brokers and hedge fund managers lately, it's clear that one of the books making frequent rounds on Wall Street recently is Bringing Down the House, a best-selling account of a scheme by MIT students to win millions at blackjack in the 'Nineties.
No doubt, the general revival of popular interest in gambling culture is part of Wall Street's focus on the betting life these days. The unlikely success of the World Poker Tour on the Travel Channel has been echoed by the hit Celebrity Poker Showdown on the Bravo network. It's no surprise that reality-TV impresario Mark Burnett (the culprit behind Survivor and The Apprentice) has created The Casino, which premiered this month.
James McManus, author of another hot poker-related book, Positively Fifth Street, makes a broad claim in the introduction to the new anthology Read 'Em and Weep. "The case can be made for poker having supplanted baseball as our national pastime," he ventures. "What used to be called 'the cheater's game' is now, for better or worse, at the heart of America's romance with market democracy."
Extending this line of thought a bit, the gambling-oriented books in favor today may qualify as this year's Moneyball, the Michael Lewis book about the "value investing" approach favored by Oakland A's general manager Billy Beane in acquiring baseball players.
Released a year ago, Moneyball was perhaps the most popular non-financial book in years to penetrate the consciousness of professional investors, who eagerly gave it to clients and invoked "Billy Beane-ism" as shorthand for their stock-picking strategy. It got to the point where references to Moneyball in fund managers' annual shareholder letters quickly attained cliche' status.
Moneyball showed that ballplayers were systematically mispriced because of the hidebound attitudes of talent evaluators, the sloppy use of statistics and a misapprehension of what traits contribute to winning. It offered hope to money managers who continued to search for the profitable key to selecting stocks that the market has missed.
Bringing Down the House is a more vicarious pleasure, but one that appeals to Wall Streeters' hope for stumbling on to a "system" that lets them get the better of the competition in a game with the odds arrayed against them.
As if to underscore the common threads, Amazon.com lists Moneyball as the first suggestion among other books as a reader of Bringing Down the House might enjoy. And to complete the loop, the Amazon page for Moneyball refers readers to investor-focused works like Enron post-mortem The Smartest Guys in the Room and Michael Lewis' first book, the men-behaving-manly Wall Street memoir Liars' Poker.
The blackjack-as-stock-trading analogy is a tempting one for investors to seize, mainly because blackjack is a "beatable" game, given enough statistical computing power, strict discipline, a permissive casino boss and sufficient capital to weather the vagaries of hand-by-hand luck.
Market pros also like the comparison because blackjack "is the only casino game of chance whose outcome depends on past outcomes," as John Allen Paulos writes in A Mathematician Plays the Stock Market. That's because each player sees all the cards that have been dealt and then can compute the odds of any unseen card being dealt from the remainder of the deck.
There are other simplifying aspects of blackjack that may draw investors' interest. A player bets only against the house, whose dealer must adhere to rigid rules known by everyone. For instance, the dealer will take another card until he or she has a 17 or better, or has busted by having taken cards that add up to more than 21.
If only the stockmarket were so straightforward.
Sure, investors routinely extrapolate past performance to project future investment results. But everything from academic studies to mutual fund disclaimers exposes the fallacy of relying on the historical record to infer performance down the road. And in the markets, no investor knows, in advance or after the fact, what "rules" are motivating the investor on the other side of the trade.
Justin Wolfers, a Stanford professor who is joining the staff of the Wharton School at the University of Pennsylvania, has shown that legal sports-betting "markets" are mostly as efficient as financial markets. And they're inefficient in some of the same ways, mainly rooted in participants' behavioral biases.
For instance, deep long shots in horse racing are systematically over-bet, meaning that 50-1 shots win far less often than once in 50 times. In the same way, deeply out-of-the-money stock options are routinely priced higher than their theoretical value. This may be due to a 'What the heck" impulse among players, and a human inability to distinguish long odds from truly miniscule odds, says Wolfers.
(continued below)
Barron's
Monday, June 28, 2004
Two of a Kind
With a poker face, Wall Street sees a similiarity between a game and its own game
by Michael Santoli, Senior Editor
(continued from above post)
Poker gets the most play as a Wall Street metaphor, for good reason. Both it and investing are "probabilistic" pursuits, requiring imperfect analyses of many possible outcomes.
Both are games of incomplete information, meaning that players can only estimate their odds of success, because certain factors remain unknown.
Perhaps most interesting, both investing and poker both expose behavioral tendencies that can spur irrational decision-making and can be exploited by other players.
Clearly, those who put money on the line in either game recognize they are taking their chances on the course of subsequent events - no guarantees. The trick is for poker players and investors to train themselves to think in terms of probabilities, understanding that a large portion of the bets that look good when they're made will go sour. Winning, in both cases, is a matter of coming out ahead a slim majority of the time.
Stocks and poker being games of incomplete information distinguishes them from other games requiring intellect and wits. Chess, for instance, offers full transparency and symmetry of information to both players, which means there can often be an unambiguously "correct" move.
In the markets or at the poker table, only educated guesses are possible. There are known probailities (how many kings might be left to be dealt, how often a stock has outperformed the market after hitting a certain valuation), which must be blended with unknowable facts to generate tactical decisions.
Also in both venues, the concept of "expected return" is useful. Stock analysts can compute price-earnings ratios, project earnings growth, plug in prevailing interest rates and use other measures to arrive at a theoretical expected return for a stock, just as a poker player can figure the odds of a pair of queens winning a hand, given other common cards that are showing. But, in either case, that expected return is only a starting point.
All these theoretical similiarities may be of some interest, but what's truly illuminating about comparing poker with stock picking is the role of human nature and behavioral tendencies to determe success or failure.
A behavioral quirk common to stock and card palyers is that so many inferior competitors happily go up against better-equipped sharks. The illusions of simplicity and the chances of lucking into a big payday make for a steady supply of dumb money.
Notes David Sklansky, in his definitive The Theory of Poker: "It doesn't take long for pool players or golfers to realize they're outclassed and to demand to be handicapped, but losers in poker return to the table over and over again, donating their money and blaming their losses on bad luck, not bad play."
The traits that determine good play from bad are pretty much the same, whether flipping chips or stocks.
The Legg Mason Funds' chief investment officer, Michael Mauboussin, cites three common attributes of the most successful
investors: a focus on process versus outcome, a constant search for favorable odds and an understanding of the role of time.
The focus on process is a matter of discipline, making sure decision-making is sound and sticking with it even when the result
is sometimes negative. Recall that this is a probabilistic game, where the object is simply to win more often than lose, and to win more money when winning than is lost when losing.
Sklansky offers what he calls the fundamental theorem of poker: "Every time you play a hand differently than the way you would have played it if you could see all of your opponents' cards, they gain; and every time you play your hand the same way you would have played it if you could see all their cards, they lose."
This is akin to a good investor's ignoring short term price movements that affect a portfolio, while constantly reviewing the thesis behind each stock holding to ensure that it's sound.
A bedrock piece of poker wisdom is to play a hand only when you see the odds in your favor, or, in gambling terms, when you "have the best of it."
Says Sklansky: "Serious gamblers bet only when they have the best of it; when they have the worst of it, they pass."
And, say the experts, when you have the best of it, wager aggressively, to drive up the value of the pot. If a hand is good enough to hold and to "call" other players bets, then it should be good enough to "raise" them.
Doing this isn't easy for many, if not most people. Behavioral research consistently shows that humans are risk-averse when it comes to gains but reckless when trying to avoid losses. In the market, this tendency means that investors lock in profits too quickly on stocks that have risen and stubbornly hold on to losers too long (or add to positions as they fall) in hope of "getting even."
Randy Cohen, the Harvard Business School professor who spoke to the analysts group on poker recently, describes different hands as being high- or low-volatility hands.
Working toward a straight or a flush - hands that become more likely the more cards are dealt - is like owning an option, or being long volatility. This means the player should bet low and try to make the game last longer, to improve the chances of completing a winning hand.
Holding a high pair is like being short volatility, meaning the chances of prevailing fall as other players get more cards. Here, the player should bet aggressively to scare off other bettors and end the game quickly.
Of course, knowing the odds and living by the probabilities is only one part of winning at poker. In the short term, luck can crump brains. But in the long run, the small minority of players possessing skill and discipline can overcome random chance.
Sounds a bit like Wall Street, doesn't it?
BOOKS THAT ARE A GOOD BET
There is rich literature dealing with
poker and other types of gambling,
including some recent best sellers to
go along with the classic texts that
sketch out the essentials of wagering.
Bringing Down the House - Ben Mezrich
A briskly written, real-life tale of several
MIT students who used a sophisticated
card-counting scheme to take several
big casinos for millions in blackjack winnings.
The Theory of Poker - David Sklansky
A venerable treatise on the game, now
in its fifth printing, which offers sharp,
and clearsighted advice for anyone
preparing to approach the gambling table.
Positively Fifth Street - James McManus
Assigned to cover the World Series of Poker,
the author actually entered it. The result is
a finely composed portrait of the pro poker
scene, braided with the story of an infamous
Las Vegas murder case.
Read 'Em and Weep - John Stravinsky (ed.)
Subtitled A Bedside Poker Companion,
this amusing and eclectic collection features
writings by authors ranging from Bertolt Brecht
and Stephen Crane and David Mamet and
John Updike.
____________________________________________________
A timely, article by a well-known financial writer from a top business investor weekly magazine.
Monday, June 28, 2004
Two of a Kind
With a poker face, Wall Street sees a similiarity between a game and its own game
by Michael Santoli, Senior Editor
(continued from above post)
Poker gets the most play as a Wall Street metaphor, for good reason. Both it and investing are "probabilistic" pursuits, requiring imperfect analyses of many possible outcomes.
Both are games of incomplete information, meaning that players can only estimate their odds of success, because certain factors remain unknown.
Perhaps most interesting, both investing and poker both expose behavioral tendencies that can spur irrational decision-making and can be exploited by other players.
Clearly, those who put money on the line in either game recognize they are taking their chances on the course of subsequent events - no guarantees. The trick is for poker players and investors to train themselves to think in terms of probabilities, understanding that a large portion of the bets that look good when they're made will go sour. Winning, in both cases, is a matter of coming out ahead a slim majority of the time.
Stocks and poker being games of incomplete information distinguishes them from other games requiring intellect and wits. Chess, for instance, offers full transparency and symmetry of information to both players, which means there can often be an unambiguously "correct" move.
In the markets or at the poker table, only educated guesses are possible. There are known probailities (how many kings might be left to be dealt, how often a stock has outperformed the market after hitting a certain valuation), which must be blended with unknowable facts to generate tactical decisions.
Also in both venues, the concept of "expected return" is useful. Stock analysts can compute price-earnings ratios, project earnings growth, plug in prevailing interest rates and use other measures to arrive at a theoretical expected return for a stock, just as a poker player can figure the odds of a pair of queens winning a hand, given other common cards that are showing. But, in either case, that expected return is only a starting point.
All these theoretical similiarities may be of some interest, but what's truly illuminating about comparing poker with stock picking is the role of human nature and behavioral tendencies to determe success or failure.
A behavioral quirk common to stock and card palyers is that so many inferior competitors happily go up against better-equipped sharks. The illusions of simplicity and the chances of lucking into a big payday make for a steady supply of dumb money.
Notes David Sklansky, in his definitive The Theory of Poker: "It doesn't take long for pool players or golfers to realize they're outclassed and to demand to be handicapped, but losers in poker return to the table over and over again, donating their money and blaming their losses on bad luck, not bad play."
The traits that determine good play from bad are pretty much the same, whether flipping chips or stocks.
The Legg Mason Funds' chief investment officer, Michael Mauboussin, cites three common attributes of the most successful
investors: a focus on process versus outcome, a constant search for favorable odds and an understanding of the role of time.
The focus on process is a matter of discipline, making sure decision-making is sound and sticking with it even when the result
is sometimes negative. Recall that this is a probabilistic game, where the object is simply to win more often than lose, and to win more money when winning than is lost when losing.
Sklansky offers what he calls the fundamental theorem of poker: "Every time you play a hand differently than the way you would have played it if you could see all of your opponents' cards, they gain; and every time you play your hand the same way you would have played it if you could see all their cards, they lose."
This is akin to a good investor's ignoring short term price movements that affect a portfolio, while constantly reviewing the thesis behind each stock holding to ensure that it's sound.
A bedrock piece of poker wisdom is to play a hand only when you see the odds in your favor, or, in gambling terms, when you "have the best of it."
Says Sklansky: "Serious gamblers bet only when they have the best of it; when they have the worst of it, they pass."
And, say the experts, when you have the best of it, wager aggressively, to drive up the value of the pot. If a hand is good enough to hold and to "call" other players bets, then it should be good enough to "raise" them.
Doing this isn't easy for many, if not most people. Behavioral research consistently shows that humans are risk-averse when it comes to gains but reckless when trying to avoid losses. In the market, this tendency means that investors lock in profits too quickly on stocks that have risen and stubbornly hold on to losers too long (or add to positions as they fall) in hope of "getting even."
Randy Cohen, the Harvard Business School professor who spoke to the analysts group on poker recently, describes different hands as being high- or low-volatility hands.
Working toward a straight or a flush - hands that become more likely the more cards are dealt - is like owning an option, or being long volatility. This means the player should bet low and try to make the game last longer, to improve the chances of completing a winning hand.
Holding a high pair is like being short volatility, meaning the chances of prevailing fall as other players get more cards. Here, the player should bet aggressively to scare off other bettors and end the game quickly.
Of course, knowing the odds and living by the probabilities is only one part of winning at poker. In the short term, luck can crump brains. But in the long run, the small minority of players possessing skill and discipline can overcome random chance.
Sounds a bit like Wall Street, doesn't it?
BOOKS THAT ARE A GOOD BET
There is rich literature dealing with
poker and other types of gambling,
including some recent best sellers to
go along with the classic texts that
sketch out the essentials of wagering.
Bringing Down the House - Ben Mezrich
A briskly written, real-life tale of several
MIT students who used a sophisticated
card-counting scheme to take several
big casinos for millions in blackjack winnings.
The Theory of Poker - David Sklansky
A venerable treatise on the game, now
in its fifth printing, which offers sharp,
and clearsighted advice for anyone
preparing to approach the gambling table.
Positively Fifth Street - James McManus
Assigned to cover the World Series of Poker,
the author actually entered it. The result is
a finely composed portrait of the pro poker
scene, braided with the story of an infamous
Las Vegas murder case.
Read 'Em and Weep - John Stravinsky (ed.)
Subtitled A Bedside Poker Companion,
this amusing and eclectic collection features
writings by authors ranging from Bertolt Brecht
and Stephen Crane and David Mamet and
John Updike.
____________________________________________________
A timely, article by a well-known financial writer from a top business investor weekly magazine.
OK, I'll buy into the premise that poker may be the new pastime.
Why not? It beats one's once-loved baseball, and the proliferation of the now-pervasive pseudo reality shows - hands down. (That time would better spent actually playing at the poker tables, or observing and learning the basics from the cable or internet venues, IMO.)
Michael Santoli pretty well covers the table in his metaphorical article - almost as though he's also spent some time with ET'ers right here on tradernik's now long-running popular thread! All kidding aside, the many gaming-as-to-investing/ trading points that Santoli connected so well should serve to stimulate many a Poker and the Beginning Trader thread-contributor well into the future.
Although Barron's (hence the article's) target market is the "business investor", in my view, trader, player, gambler can be easily substituted in most of the examples.
A small apology to Messrs. Santoli, Miller, Nelson, McManus, Lewis, Paulos, Wolfers, Sklansky, Maumoussim and Cohen for somewhat fracturing their efforts in this post's lengthy quote; it was just a matter of recognizing and sharing the essence of their views in a typically short forum time frame. The goal is for subsequent posters to treat any or all of the subject matter more astutely than has this poster.
Several descriptions (here's two) in Santoli's article remind me of one particular long-time poker player and trader, who, as an avid finance and macro-economics reader, favors Barron's as his stock market newspaper:
"blackjack-as-stock-trading analogy" and "what traits contribute to winning"...
According to brother Don, Bob had some things to say about Michael Santoli's article Two of a Kind? on the Bright Brothers radio show, the day that Barron's issue hit the newstands - Saturday, June 26th.
I got a royal flush on Party a while back. All I could talk them out of was a baseball cap.
Did win a few bucks, as one of the other players had a lesser non straight flush.
Did win a few bucks, as one of the other players had a lesser non straight flush.
