In her recent book Thinking in Bets: Making Smarter Decisions When You Don’t Have All the Facts, Annie Duke positions poker-playing as a model for all types of decision-making under conditions of randomness and incomplete information - including investing.
When investing in stocks, you have to make financial decisions while holding only partial information about each company and its market, and the company is continually facing a stream of unpredictable events. Poker is a model for these conditions, given the unknown hole cards (face-down) and the stream of uncertain next cards to be uncovered. Poker is clearly a better model for investment than chess, which has no randomness and all players have complete information.
But beyond the similarities, there are also some key differences between the stock market and the poker table, differences which affect the relative ease of walking away with a profit.
Stocks are Easier
Here’s why the stock market is a easier place to make money than the poker table: Poker is a zero-sum game. When friends gather around a table for a neighborhood poker game, each player’s money is represented by a group of poker chips. Over the course of play, those chips move around from player to player, as each hand is decided. At the end of the night, the chips have been redistributed amongst the players, from the losers to the winners.
But - the crucial point - the number of chips are exactly the same at the end of the night as they were at the beginning. No chips were destroyed, none were created; they were just redistributed. Poker is called a zero-sum game because of this property; the wins and losses of all the players add to zero.
The stock market, by contrast, is a positive-sum game. The total value of all stocks in the S&P 500 is much larger than it was 5 years ago or 50 years ago. Consider this chart of the Russell 3000 (which represents the value of more than 98% of the stock market) over the last 40 years:
Source: Federal Reserve Bank of St. Louis
This is not just a “slight bias toward the upside”. The stock market has increased by a factor of 90 over this time period, despite drawdowns such as that associated with the financial crisis of 2007-2009. The stock market players are not walking away from the table with only the chips they started with, but with 90 times more than they started with!
Imagine if there was a magic poker table that could create new poker chips and add them into the pot. How much easier it would be to walk away a winner at the end of the night! Of course if we really followed this analogy, the magic table could also swallow up some chips (representing days or years when the stock market declines), but such that over the years and decades the new chips created greatly outnumber the chips swallowed up.
It’s appropriate here to recall that the long-term gains by the stock market are not magic, but are a reflection of the growth of the overall economy, as represented by the value of the businesses making up that economy.
Note that for you to win a single dollar in a poker game, that dollar must have come from another player: you cannot win a chip unless another player loses that same chip. You’re not just “winning a dollar” abstractly, but you’re “winning a dollar from player X”. People hate to lose their money, so the other players are going to fight tooth and nail to prevent you from taking their dollars. That’s the dynamic in a zero-sum game.
But in a positive-sum game (like the stock market), you can win a dollar, and the other guy (player X) can also win a dollar. So he doesn’t need to fight hard to block you from winning a dollar, but instead can concentrate on getting his own share of that newly created money. If he does well, he’ll win his own new dollar, maybe even two new dollars, and then he won’t begrudge you your winnings.
Stocks are Harder
But actually stock investing is a much more difficult game than poker. In poker, the deck is always the same 52 cards, and the rules of the game are fixed and fully disclosed before play begins. This allows you to calculate the odds of an ace being the next card turned up, or of your opponent making his inside straight, or myriad other events that affect the outcome of each hand. True, you don’t know your opponents’ face-down cards, but you do know the probabilities of what they could be, based on the make-up of the deck and the already-known cards in the hand.
In the stock investing game, you don’t know the odds of each outcome, and you can be blindsided by a completely unexpected event; if you’ve been investing for more than a year or two you probably know this first-hand.
You may focus on a specific business outcome: what are the odds of a particular company gaining market share next year, or of a new competitor entering its space, or of a proposed merger being approved by the government? You can make estimates of these odds, based on assumptions such as “current market share trends are likely to continue” or “antitrust policy is equally lenient or strict as it was 11 years ago when a similar merger was proposed”. Such estimates may or may not be accurate. Usually the assumptions baked into such estimates are variations of “the future will be similar to the past”. And that may be true in most cases. But sometimes it is wrong - very, very wrong.
Often you cannot judge even after the outcome is revealed whether your probability estimate was correct; in poker you can later either mathematically analyze a hand, or replay it repeatedly (in private) to empirically approximate the chances of various outcomes.
And with stocks, the circumstances are continually changing; even if you correctly assess the probability of merger approval in one case, that probability may not hold for the next merger, since government policy and personnel change.
Suppose you sat down at a strange poker table in a strange land, without the full set of rules, and were told that the poker played there was only roughly similar to normal poker, and further that the rules could change from time to time, unexpectedly and unannounced, and that the deck had an unknown number of cards (that changed from hand to hand), with an unknown number of suits and ranks. That’s poker played like the stock market.
So I hope I’ve answered the question clearly. Is making money by stock investing easier than poker? Yes. Is it harder than poker? Yes again.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.