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Scotia Wealth Management

Poker and investing

Game theory

April 5, 2018

Seasoned insiders operating within the wealth advisory industry know something that a great many – often exceptionally experienced and successful – private investors don’t know.
It is that several of the best known U.S. money managers, including Peter Lynch, Bill Gross, David Einhorn, Steve Cohen, and Warren Buffett, have admitted that one of the most valuable educational tools for a would-be-investor is playing poker.

Many of the so-called quants – masters of the algorithm-driven, digitized money making machines who operate some of the world’s most successful hedge funds – are typically aficionados of poker, too.

As reported in The Wall Street Journal by Gregory Zuckerman1 (Renaissance Feud Spills Over to Hedge Fund Poker Night, April 28, 2017), these quants are the mathematical hotshots who participate in the annual hedge-fund poker tournament held at New York’s St. Regis hotel.

The event is a benefit for Math for America2, a non-profit organization founded in January 2004, whose mission is to promote recruitment and retention of high quality mathematics teachers in New York City secondary schools.

And the variation of poker most of them like best? Texas Hold ‘em.

Texas Hold ‘em

Writing in Kiplinger, a Washington, D.C. based publisher of business forecasts and personal finance advice, Senior Editor Bob Frick presented an excellent analysis of card playing in a piece called: How Texas Hold ‘em Simulates Investing3.

Wrote Mr. Frick: ‘Of all the gambling games, Texas hold ’em best simulates investing. Other gambling games can spark the same errors, but poker is closer to investing because a good player can win consistently (whereas players will lose over time with games of chance such as roulette and blackjack). And Texas Hold ’em involves many decisions per hand.’

Incomplete and unfolding information

Mr. Frick quotes Frank Murtha, a behavioural finance consultant and co-founder of Marketpsych4 – an investment advisory practice dedicated to distilling the sentiments and emotions of financial markets – who observes: ‘The stock market and Texas Hold ’em are games of investing based on incomplete and unfolding information. The goal of each is to accumulate wealth by making decisions based on that information.’

Mr. Frick states: ‘Researchers have long known about the gambling/investing connection. In fact, gambling is often used in laboratories to test psychological reactions that are also common to investing.’

A variation of seven-card stud

Texas Hold ’em is a nuanced variation of seven-card stud. Each player receives two cards face down, followed by a round of betting. Three community cards are then placed face up in the middle of the table, followed by another round of betting. Another community card is dealt, followed by more betting. Then the final community card is dealt, followed by the final round of betting.

How does this simulate investing?

How does this simulate investing? Mr. Frick’s answer is clear and concise: ‘Think of your first two cards as a potential investment – say a stock, mutual fund or bond. Your first decision is: Do I want buy it (bet) or pass on it (fold)? If you decide to buy it, you have made an investment, and you’re given the same choices that you get with any investment you own: buy more of it (bet), hold it (check), or sell it (fold). Every time community cards are shown, you get more information about your hand, which is just like getting more information about your investment. And every decision point can be a lesson in controlling your emotions.’

Enter game theory

Looking at the gambling connection more forensically, analysts see that Texas Hold ’em has a great deal in common with game theory5, the study of human conflict and cooperation within a competitive situation.

Defining the discipline more rigorously, Investopedia adds: ‘Game theory is the science of strategy, or at least the optimal decision-making of independent and competing actors in a strategic setting.’ Sound familiar?

Conclusion

Texas Hold ’em has been described as a mixture of game theory, stagecraft and a crapshoot — rolled into one nerve-wracking high stakes package. It is said that those it seriously rewards, such as successful long-term wealth advisors, high rolling hedge fund managers and – like you perhaps – seasoned personal investors, have four things in common:

  1. A grasp of probability, based on solid mathematical skills.
  2. Prodigious intuitive resources.
  3. Strong stagecraft instincts.
  4. Nerves of steel.

Aah yes, and there’s something else. Texas Hold ‘em aficionados, several professional Wealth Advisors I know, and more than a few seasoned personal investors of my acquaintance are not afraid to make carefully calculated risks. That’s what makes investing so much fun.

Tristan Sawtell, Wealth Advisor, Scotia Wealth Management: 604-661-1475

1 https://www.wsj.com/articles/renaissance-feud-spills-over-to-hedge-fund-poker-night-1493424763
2 https://en.wikipedia.org/wiki/Math_for_America
3 https://www.kiplinger.com/article/investing/T052-C000-S001-how-texas-hold-em-simulates-investing.html
4 https://www.marketpsych.com/
5 https://www.investopedia.com/terms/g/gametheory.asp

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