In the investing world people love to draw parallels between poker and investing, and rightly so since there is a strong link between the two activities. For example risk taking, risk management and being process oriented all play a crucial roll in both. But most of the parallels are drawn by investment professionals that try to project wisdom from a field they understand to a game they don’t know a whole lot about. So as a poker professional I thought it would be a nice idea to explain some of the more subtle differences, and tell you some of the lessons that I learned from poker.

Random outcomes and knowledge inequality

I basically know nothing about chess besides the rules of the game, but I think that it isn’t hard for a novice to figure out who’s a good chess player and who isn’t. The amount of luck involved in chess is relative low, and you can simply check ELO-ratings to see how good someone is. I understand that Magnus Carlsen knows what he’s doing. When you add a significant random element to the game the evaluation of skill becomes a lot harder, and it becomes easier for mediocre players to pretend that they are better than they are.

In poker there is a vibrant market place for coaching. Poker is a complicated and evolving game: what you read in books is either outdated, never correct to begin with, or theoretically correct, but very general and not directly usable. Figuring everything out on your own isn’t doable, so hiring someone more knowledgeable to speed up your development as a player makes sense. But this is easier said than done, because how do you find a good coach? There are plenty of mediocre players that aren’t very good at poker, but good at marketing themselves (disclosure: I also offer poker coaching and I like to think I’m bad at marketing and good at poker).

You can’t simply look up an ELO-ranking and determine someones skill level, and if you are not an expert level poker player evaluating how good the advice is that you get isn’t trivial. For those that know something about poker, take for example this spot: you are out of position in early position at a six handed table with ace-queen offsuit and you get re-raised by the button (an expert level player). What should you do? I could easily create a convincing argument for folding, calling and re-raising. You are out of position with a hand that is dominated by ace-king and premium pocket pairs, so fold? It’s one of the better starting hands in your range and you don’t want to be exploited by bluffs, so call? You have blockers in your hand that reduce the probability that your opponent has aces, ace-king or queens,  so re-raise as a bluff? If you are a novice poker player there is absolutely no way that you can pick the right option with the correct argument, but feel free to take a stab at the problem in the comments :).

In the investment world the inequality in knowledge is an even bigger problem. You have a huge number of people that know nothing about investing, don’t want to educate themselves, but they do have money and they do want to do something with it. So you can basically sell them anything if you have the right sales pitch, and it’s even harder to evaluate the skills of an investment manager than the skills of a poker player. If you carefully analyze the last one or two years of someone’s play you can determine with a reasonable narrow confidence interval someone’s winrate. Getting a sufficiently big sample size for an investment manager is a lot more problematic, and once you have a big sample size odds are that the historical sample is not representative anymore for the current situation.

Sad news is that it’s probably a problem that can’t be fixed, but that’s a good thing for active investors. You cannot outperform without someone else under-performing.

Playing tight

Buffett is known for saying that there are no strikes in investing, implying that an investor will do best if he is extremely selective with the stocks he buys. On the surface a similar principle seems to be true for poker since most winning poker players play tight: meaning they are selective with the hands they play as well. Problem is that this is where the comparison breaks down: in poker there are ‘strikes’ for not playing because you are forced to put money in the pot through antes and blinds. You have to be selective with the hands you play, but you can’t wait for a fat pitch.

As a matter of fact, it’s even more extreme. If you don’t want to leave money on the table you should play hands when you expect to make zero profit! The reason for this is that a hand with an expected value of zero on it’s own adds value to the better hands that you play. As an extreme example: if you would play only aces (the best starting hand in holdem) an intelligent opponent wouldn’t give you a lot of action, if any at all. But if you also add some crappy hands to your range that individually don’t make (but also don’t lose) any money he is suddenly forced to give action to your aces because otherwise he could be bluffed all the time by the weak hands. So the expected value of your best hands are improved by adding very marginal hands to your range. I don’t think anyone would advocate investing in stocks when you don’t expect to make money.

Pick your own style

Another difference is that there are probably a lot of things that can work when investing. You can buy NCAV bargains, distressed debt, buy growth at a reasonable price, high quality moat companies and that’s just the tip of the iceberg of potential profitable strategies. Common investment advice is that you should stick to a strategy that you are comfortable with. How good that advice is for investment is another discussion, but it certainly isn’t good poker advice.

In poker there is no big selection of different viable long-term strategies. Against bad players there are a lot of winning strategies, but against each other some strategies are better than others. A strategy in Tic-Tac-Toe that would start at the edge of the playing field would be an example of a dominated strategy, and it wouldn’t be successful unless your opponent is really bad. In poker you also can’t really choose how you want to play if you want to make money because playing a dominated strategy gives your opponents room to exploit you. With knowledge about the game increasing strategies are slowly converging to a game theory optimal solution. People unable or unwilling to adapt ‘their style’ drop out.

Wrapping it up

Enough rambling, time to wrap it up before this post gets even longer. Hopefully you learned something new, and if not: sorry for wasting your time ;).