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Chris DeMuth Jr.
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"It's not given to human beings to have such talent that they can just know everything about everything all the time. But it is given to human beings who work hard at it - who look and sift the world for a misplaced bet - that they can occasionally find one." - Charlie Munger I look... More
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  • Texas Hold ‘Em Tournaments And Value Investing 18 comments
    Apr 1, 2013 1:24 PM | about stocks: DELL, AUTO

    In most casino games one plays against the house; the house writes the rules, enforces the rules, and ensures that the odds are always stacked in their favor. This activity has a negative expected value, and I would classify it as gambling. Value investing is not gambling. When properly understood and implemented, value investing has a positive expected value. In other words, value investors can find situations where they have an advantage and the odds are stacked in their favor. They may not always win, but they are not gambling.

    I am playing in a poker tournament this week, so I have been thinking about the overlap of my job as a value investor with my strategy as a poker player. Poker, unlike most casino games, is played against other individuals, not the house. So in poker, it's possible to be an advantage player and have a positive expected value.

    Tells

    Practicing one's poker face can start young

    Like many people, my education on the topic of poker tells started with the great Caro's Book of Poker Tells: The Psychology and Body Language of Poker which teaches you how to read your opponent in order to get an edge. Does anything like that exist in the investing world? Yes it does. Tactical behavior assessment services are used by certain investors to detect whether corporate executives are exaggerating accomplishments, avoiding discussing a topic, or are flat out lying.

    People are not naturally good at lying. Holding the truth and a lie in one's head at the same time is difficult, uncomfortable, and causes cognitive dissonance that shows up in both verbal and non-verbal signs. There is scientific evidence regarding how to observe and how to exacerbate these signals. In both poker and investing, it can be lucrative to know how to detect deception.

    Math

    "If you think the math isn't important, you don't know the right math."

    - Chris "Jesus" Ferguson, 2000 World Series of Poker champion

    Poker and investing are both about decisions amidst risk and uncertainty, played out in real time. The core of both poker and investing is the maximization of average profit based upon probability. In both activities, intuition is a dangerous guide. Quantitative reasoning, instead, is key to exploiting counterparties. Both rely on the branch of economics known as utility theory. Utility theorists quantify preference orders such that a utility maximizer can determine how to make rational decisions. Making the most money requires that participants maximize the expected value (EV) of decisions. To the end of maximizing EV, we use probability distributions in which we study and quantify all possible outcomes as well as their probabilities. The EV of a probability distribution is based upon the numerical value of every possible outcome.

    What is my takeaway from poker math? My major concern is this: if I could see everyone's cards, what would I do? I judge myself based upon my proximity to that behavior. There will still be losses and there certainly will always be bad cards. Who cares? The key is to have one's decisions approximate expectancy maximization as closely as possible. One should aim for perfect optimization minus only unavoidable constraints. For the investor, the analogous question is this: if you had perfect information, what would you do? Stocks will go up and down and subsequent events will hurt business, but what should your decision be today, assuming perfect information? Make those decisions, as best as you can with the information available.

    If you want to read more about poker math, I would start with The Theory of Gambling and Statistical Logic. For further reading two other superb poker books are The Mathematics of Poker and The Theory of Poker.

    Scale

    Liquidity-constrained counterparties make the best opponents. It is much easier to play an advantaged game with more chips. The Professor, the Banker, and the Suicide King: Inside the Richest Poker Game of All Time is a wonderful book about Andy Beal's triumphs at the poker table. Beal is a good poker player, but not one of the greats by professional standards. That being said, he could play a winning game of poker simply by being rich enough, and willing enough to gamble that he threw everyone else off of their games. He turned -EV to +EV by playing well enough with a very strong stack.

    In the financial markets, large investors have specific advantages based on their size, access, trading cost, timing, etc. Outside passive minority investors (OPMIs) often lose because larger players or insiders can influence a situation. DELL and OTC:AUTO are examples of buyouts where management and private equity firms receive a much better deal than outside passive minority shareholders.

    What does this teach me about investing? It tells me that I always want more liquidity than my counterparties in the capital markets. I always want relatively larger, influential stakes in the companies in which we invest. I look at the ideas that we are considering and, even before picking individual ones for the portfolio, ask myself if we are taking every advantage. Specifically, within the individual security, are we able to position ourselves relative to scale, concentration and liquidity to have an advantage. Anyone who shows up for a fair fight is unprepared, and we never show up unless we have an advantage.

    People

    Unsurprisingly, given these overlaps, many of today's top investors are also serious poker players; (the list includes Cliff Asness, Ken Griffin, Jim Simons, Boaz Weinstein, who once won a Maserati playing poker, Steve Cohen, who once quit his job so that he could focus on poker, Peter Muller, David Einhorn, Marc Lasry and of course Andy Beal). Carl Icahn got his start by winning $4,000 playing poker in the army.

    Disclosure: I am long DELL, OTC:AUTO.

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Comments (18)
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  • You should write a book for reals. Good luck in your tournament.
    1 Apr 2013, 01:35 PM Reply Like
  • Author’s reply » Thanks, Joe. Much appreciated.
    1 Apr 2013, 01:44 PM Reply Like
  • Great article!
    1 Apr 2013, 01:53 PM Reply Like
  • Author’s reply » Thanks. I'm glad you liked it.
    1 Apr 2013, 01:55 PM Reply Like
  • Dan Harrington's books are must-reads as well. The guy looks like someone off to cash in his coupon for $10 in free slot play, but he's an expected-value-calcula... machine. If he ever sits down at a table with me in any endeavor, I'm getting up.

     

    Jeff Yass (and his partners) started Susquehanna Investment Group with winnings from poker and horse betting. They're grown net worths in the billions (or at least hundreds of millions) by making massive amounts of slightly positive EV bets. SIG job interviews are nothing but being asked a bunch of probability questions. If you make it past the first couple of rounds, it's on to test your chops in poker.
    1 Apr 2013, 02:10 PM Reply Like
  • Author’s reply » SIG is a terrific shop; one of my favorites.
    1 Apr 2013, 02:13 PM Reply Like
  • Great article, this should be published.

     

    Poker does involve the house with the rake. In smaller cash games such as 2-4 limit, it is difficult to beat the rake in the long term. However, once playing stakes such as 2-5 NL and higher, the effects of the rake are much less in percentage terms, and a good player will be able to beat he rake easily.

     

    It is very interesting that a lot of hedge fund managers and successful people play poker. People tend to view it more as gambling, but in many ways there are so many similarities. I wish this article could be published to let the investing community understand the similarities.

     

    Where is your tournament this weekend?
    1 Apr 2013, 02:17 PM Reply Like
  • Author’s reply » Thanks for the comments. On the east coast.
    1 Apr 2013, 02:19 PM Reply Like
  • I'll share some books I'd recommend for NLHE tournaments. I echo what Stephen said, the Harrington on Hold'em books are great.

     

    Kill Everyone and The Raiser's Edge are also both specifically on NLHE tournaments and focus heavily on finding and applying equilibrium push/call/fold ranges for a wide variety of end game situations.

     

    I think poker is great for learning a number of things that are applicable to investing

     

    1) The importance of not being results oriented with individual outcomes. In poker, players can go through a huge stretch of making the right play in a given situation with it going against them. It's important players can put short term results in perspective and not let it change the way they play for the worse (going on tilt).

     

    2) Identifying +EV opportunities. Understanding when and what the weaker players are most interested in playing as well as understanding where your edge comes from are important.

     

    3) Bankroll management. Getting comfortable thinking about sizing risk appropriately

     

    4) Getting comfortable handling variance in results

     

    5) Self awareness and being able to judge your own abilities/weaknesses. It’s important to manage one’s ego when deciding what games to play (cash vs mtts, moving up or down in stakes, etc.) and what areas of your game to work on.
    1 Apr 2013, 02:27 PM Reply Like
  • Author’s reply » Great comments; thanks! If anyone wants to read the book recommendations from readers, here they are:

     

    Kill Everyone: Advanced Strategies for No-Limit Hold 'Em Poker, Tournaments, and Sit-n-Gos: Revised and Expanded Edition http://amzn.to/10pzdvz

     

    The Raiser's Edge: Tournament-Poker Strategies for Today's Aggressive Game http://amzn.to/179sRp9

     

    Harrington on Hold 'em Expert Strategy for No Limit Tournaments, Vol. 1: Strategic Play http://amzn.to/10pzdvD

     

    Harrington on Hold 'em Expert Strategy for No Limit Tournaments, Vol. 2: Endgame http://amzn.to/179sPO1

     

    Harrington on Hold 'em: Expert Strategies for No Limit Tournaments, Vol. III--The Workbook http://amzn.to/10pzf6H
    1 Apr 2013, 02:48 PM Reply Like
  • It's a bit unbelievable to me how many books on poker use flawed math, ranging from minor / insignificant to major / contradictory. It's also funny that the authors who do get the math exactly right are not in the top tier of players in the professional world. Only Sklansky and Malmuth have the math right. However, even the books that have the math the furthest off, like Helmuth, have a lot of useful advice outside of the math.

     

    Your article is terrific, and I have found a few other similarities between investing and poker in my experience. First, alongside Expected Value is always variance. An out-of-the-money call option and a utility stock could have the same EV, but you might have a 60%+ chance of losing your entire investment on the former. I liken Hold Em tournaments and no-limit games to high-beta investment choices, and 20-hour grinds in a limit ring game to low-beta investment choices.

     

    Second, the bad beats are very similar in the two. In both, you find yourself in situations where you should have won, only to find something very unlikely happened at the worst possible time. It's a tough feeling to live with, because there are no offsetting situations where you should have lost and got lucky to win, because in both poker and investing, if you've identified a negative EV situation, you've exited.

     

    Third, I find a strong similarity between being up big on a stock and realizing you've got the nuts. The strategy of maximizing that big win contains the same exhilaration and considerations in both arenas.

     

    I'm sure there are more....
    1 Apr 2013, 03:39 PM Reply Like
  • Author’s reply » Great comments. Thanks for posting. Bad beats are brutal. I have had a few days of investing and a few nights of poker where I step outside afterwards with bad beats and think, "gee, yeah for me to have my money in with +EV; too bad I just lost (insert 8-figures in the capital markets or five on the poker tables) today". Intellectually and financially survivable. Emotionally brutal though, every time.
    1 Apr 2013, 04:01 PM Reply Like
  • Do you have a couple examples of the wrong math?

     

    Completely agree that absolute precision does not necessarily translate to max winnings.
    1 Apr 2013, 08:21 PM Reply Like
  • That would take a long time to expand on, but the short answer is that Sklansky is an actuary turned poker player, whereas a lot of the others are poker players trying to explain complex probabilities.

     

    One example is that Helmuth ranks small pocket pairs far higher than math would suggest, but he makes them work for non-math reasons. First off, they're binary - if you don't flop your set, you're out, and if you do flop your set, they're relatively simple to play, so you cut down on the mistakes you make with those hands. Second, when the flop comes K-9-4 and you show aggression, most opponents put you on a pair of Kings rather than a set of 4s, so there's very often a stealth factor to your true strength.
    1 Apr 2013, 10:24 PM Reply Like
  • Author’s reply » Great answer; thanks.
    1 Apr 2013, 10:27 PM Reply Like
  • I was a pro poker player until Black Friday... Much better at that than I am investing.. :) but I saved a lot of it and hopefully the things I've put the money towards will pan out. Nixon was a poker great as well as those you listed, and would not have been president had he never played.

     

    I read some of your articles and you make it seem super easy to make a fortune by buying something for 7k and then getting 10k for it a few days later after the buyout or something. While the Math is there, the real challenge is findiing these deals and having the sense to go for it. It's not hard to do the math on that. Any rec's on how you find your opportunities? Other than reading your blog, It's hard to know where to start :)

     

    As far as Hellmuth rating pocket pairs too highly.... naaah.. No offense but that is just narrow talk. 22 is a favorite over AK unsuited heads up.... but is an underdog against 87 suited. Does this mean 87 suited is better than AK heads up? No. Could it be more attractive on a 5-handed flop? Sure, could be. Depends.

     

    Not saying Hellmuth is right about everything, but there is no 'math would suggest' on hand rankings. Hand rankings are situational, and cannot be considered in a mathematical vaccuum, period. I'm happy to run your AK against my 22 100,000 times at $1,000 bux each and then run my 87 suited 100,000 times against your 22 at $1000 bux each for anyone who disagrees.
    2 Apr 2013, 05:32 AM Reply Like
  • Author’s reply » Great comments; thanks. How to find opportunities? Different people have different answers that work for them; here is what I do. Mostly, I find them in SEC filings. Other times from press releases. I search them for:
    •Mergers and acquisitions – One company purchases another
    •Spin-offs – A company splits off portions of its business into new, independent companies
    •Demutualization – A mutual bank or thrift converts to a public shareholder owned institution
    •Restructuring – When a company reorganizes its operations, ownership structure, etc
    •Litigation – Investing in a company based on the outcome of a legal proceeding
    •Legislation – A company is impacted by new or changing legislation
    2 Apr 2013, 07:07 AM Reply Like
  • Thoughts... You need to spot emerging trends and then find companies who are positioned well to capture revenue from those future trends...
    2 Apr 2013, 11:02 AM Reply Like
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