Saturday, December 05, 2009

Poker, Investing and Market Follow Up

1. One of the many parallels between poker and investing is the rhythm in betting. For example, in poker I'm constantly adjusting my style to the position, or where I sit relative to the dealer. For example, if I'm first to bet, I'm less likely to play aggressively given that I'm uncertain on how the other players feel about their cards. In short, it's foolish to make a strong bluff, when any one of the nine players ahead of you could have stellar cards. That's the point of playing position, you're constantly monitoring the flow of information from other players. Maybe Mr. Alligator Blood quickly called the bet from the drunken roommate, so maybe I shouldn't raise pre-flop.

In investing, similar to knowing your position in poker, you must know where you are relative to the general market. The more bullish the crowd, the more bearish get. It is for this reason that after a 60% rally, I don't go "guns blazing" into any investment. I currently sit with a 5% short on the market, 5% long Berkshire, and 90% cash.

Another similarity between poker and investing is the discovery process of the fulcrum security. For example, during a contentious bankruptcy usually there's a valuation fight where creditors argue for how much debt the underlying company can support. This is a critical process because it frequently determines which lender gets the post-reorganization equity, and which lender gets nothing. The lower you are in the company's debt structure, the less likely you get a pay day.

In poker, I like to think of the fulcrum security as the minimum bet necessary to cause the other players around the table to question what they have with the goal of having them fold. What's fun about this is that it's a constantly evolving discovery process. While usually I think the fulcrum bet is somewhere between 5 to 10% of the initial buy-in, it can vary based on how long the game has been playing, the amount of alcohol consumed, the familiarity of the players and countless other factors.

Anywho, those are just my random musings on cards vs. investing, and that said there are many differences between the two that need to be appreciated and will be discussed in the future. Until then one of may favorite quotes that captures the difference is from a recent Bloomberg article: “In poker, people are used to not sitting back and waiting for the fat pitch...they’re used to skirting the edge of ruin and they learn the tools of how to do that.”

2. To follow up on my last post on shorting the market, I've settled on not betting. While I have strong conviction that we are due for a near-term pull-back, the risk return profile (like pot-odds) totally isn't worth it. For example, how much can I profit from betting against the market? In all likelihood the range is from 10-30%. Given that I almost never buy stocks with only a 30% upside, why should I make an exception for shorting the market? The answer is that I shouldn't. Despite the frustration of sitting on the sidelines (much like the frustration of mucking a lot of bad hands), a full chip stack is worth a lot more when everyone else is panicking.

1 comment:

Kelvin said...

As I learned the hard way the other night, sometimes the best thing to do is to sit tight and be patient.

Thanks for sharing this. I thought it was really interesting.