People may consider Poker to be a game of luck & gambling. But this is quite far from the real truth. Luck may play a part but rules, principles, odds and proper money management are the largest components of Poker, as well as investing.
A little introduction about poker would be helpful here.
Poker is a game of decisions based on having a sampling of the general information. It is all about having an ability to cut losses in risky situations by calculating odds, using a skilled memory and taking quick decisions under pressure. (Wikipedia offers all basic information about Poker and its variants).
Now the similarities between Poker and Stock markets are –
You can start small. But if you are sure, be ready to take bigger bets
Most poker players enter the game at ease. They place small bets until they have a fair idea about playing styles of other players & their own ‘luck’. Stock markets also allow one to start small. It helps in knowing whether one’s investment philosophy is profitable or not and whether same can be replicated with bigger bets or not. Poker allows one to raise bets if one is confident. Stock markets also allow one to increase their bets depending on confidence or overconfidence.
Controllable Vs Uncontrollable
Just like in Poker, there are only two factors in stock markets– Controllable and Uncontrollable. One must respect the fact that there are bound to be things that cannot be controlled. For example, in Poker one can neither control other player’s emotions nor the cards being dealt. Similarly in investing, one cannot control the overall markets or various events taking place which have an effect on stocks. But that does not mean that one should leave investments at market’s mercy. It means is that one needs to have a greater awareness about his environment.
In poker, a player knows that there are times when luck may not favor him. However, instead of playing blindly, he focuses on what can be controlled: his own reactions. For investors, it means knowing what is going on in the world and knowing how these things could affect one’s investments. So when a political, economic or social event occurs, you know how to react to save your investments.
Knowing when to Fold
In poker, the players who stay in the game the longest (& reap the biggest rewards) are those who know when to fold. One should understand that, not every bet may be favorable. It is better to cut losses and wait for a better opportunity. Same is the case with investments. Not every investment is going to have a high return. Some may fail. To avoid losing more money than usual, one should learn when to pull out of an investment.
There will be another opportunity
In both the games, there will always be another opportunity. So its better to wait for it to take a bigger bet. Its saner to live today and fight (play) tomorrow.
All-In can be the last decision you make
You put all your eggs in one basket and you risk losing everything. In investments too, a focused diversification is more advisable than single point focus.
Poker requires skill in reading one’s opponents. A player must understand when other player has a really good hand or is merely bluffing. Otherwise he will always end up losing money. One must also be sensitive about how others perceive him. This in turn can be used to one’s advantage. Markets also bluff when some stocks go up in prices because of speculation or manipulations. Knowing the true value of a stock is based on knowing how humans think and rationalize.
Evening out the odds
Both poker and stock markets require a proper strategy, which is in synch with a player’s real self. Luck can only do so much in the way a game turns out. A poker player must know how to read the odds. He must know when to raise the bets and when to call a bluff. He must know which cards to keep and when to fold. Likewise, an investor has to know when to cut his losses and wait for another opportunity to score big. It in essence requires a long-term strategy based on solid facts rather than emotions. A stock market investor must always ask the question – What are the odds that a stock is going to rise? More importantly, one must ask the question -What are the odds that this stock would go down? And by how much? What is the worst case scenario?
In long-term poker play & long term stock market investing, somebody who has no strategy is as good as broke and one who merely goes with the flow is as good as busted.
Successful investors like Warren Buffett are regular Poker players. Just like in his investing, he is known to focus on players rather than the cards. He once remarked that –
If you’ve been playing poker for half an hour and you still don’t know who the patsy is, you’re the patsy.
All in all, the number one goal in poker as well as stock market investing is to preserve capital (return of capital is more important than return on capital). At the same time, the player must be willing to place big bets when the odds are favorable.
It’s time of the year when Warren Buffett comes out with his annual letter to shareholders (Letter 2012). As always, it’s full of insights into the mind of Oracle of Omaha. An interesting point (on Value) made by Warren in the latest letter is –
“If you are going to be a net buyer of stocks in the future, either directly with your own money or indirectly (through your ownership of a company that is repurchasing shares), you are hurt when stocks rise. You benefit when stocks swoon. Emotions, however, too often complicate the matter: Most people, including those who will be net buyers in the future, take comfort in seeing stock prices advance. These shareholders resemble a commuter who rejoices after the price of gas increases, simply because his tank contains a day’s supply.”
So what can a Stable Investor learn from this quote?
- If you have time and can invest for decades (if not years), then you should pray for bear markets. Bear markets offer shares of beautiful businesses at delicious valuations! Though short term rise in share prices may make us happy, one must not forget that for a long term investor, these are just paper profits!
You can read key takeaways from the letter here, or if you are an ardent fan of Warren Buffett, then you may like to go through the entire letter yourself (Warren Buffett’s Annual Letter to Shareholders 2012).
You can also read previous letters to shareholders.
Caution – Though these letters may make it look easy to earn high returns in market, the fact remains that we are not Warren Buffett(s)! 🙂
In an earlier post about timing the markets, we saw that it doesn’t make sense in trying to time the markets. If earning a better-than-average return is the aim, it is enough to invest regularly in a disciplined manner rather than trying to time the markets.
Let’s suppose that you as have decided to invest at regular intervals. This type of investment can easily be executed by means of SIP or Systematic Investment Plans.
Update (September – 2016) – You can read an updated and more detailed analysis of PE done in 2016 here.
We decided to use this insight to boost our SIPs.
For our analysis, we started with SIP of Rs 5000 every month, from January 2000 and kept on investing till December 2011. A total of Rs 7.25 Lac was invested in 145 instalments. Now we add the Boost. Whenever markets PE fell below 15, an additional Rs 5000 was invested in that month i.e. a total of Rs 10,000 was invested in that particular month. This happened in 23 of the 145 months and an extra Rs 1.15 Lac boosted the normal investment of Rs 7.25 Lac. This took total investment to Rs 8.40 Lac.
So what is the current value of the investment. Did the boost help in earning higher returns? Read further. The investment of Rs 8.40 Lac stands at a Rs 23.8 Lac. And if SIP was not boosted by Rs 1.15 Lac, it would have stood at Rs 19 Lac.
So to summarize,
- You should understand that there is no point in trying to time the market.
- Best way for common investors to enter markets is to invest via mutual funds and take the SIP route.
- If you are ready to track overall market PE regularly, you can augment your SIP investments as detailed above.
- But even after discussing the benefits of regular investments in markets & redundancy trying to time the markets, if you want to time the markets by investing in direct stocks, you should stick to shares of large & stable companies (Read about how to find Large Caps selling at massive Discounts!)