KPL's blog on Indian stock markets, science, technology and more
SEBI Registration (Research Analyst) : INH000000743
April 17, 2016
5 similarities between poker and stock market investing
1- Variance is at poker what volatility is at stock market
Whoever has played poker before knows that luck is part of the game and that in the short term, bad luck can be pretty brutal sometimes too. In poker, we call that variance. Variance is a measurement of the spread between numbers in a data set. It aims to measure how far each number in the set is from the mean or expectation. In short, higher is the variance, the more the actual results can be far from the expectation; lower is the variance, closer they will be to the mean or expectation. In poker, when you take a good decision, sometimes bad luck still makes you lose the hand. The actual result is then inferior to the expected result. However, if you repeat this good decision hundreds or even thousands of times, in the end luck will almost completely be out of the equation.
In stock market, we will rather talk about volatility. In finance, volatility represents the extent of changes in the price of a financial asset. Like in poker, it’s possible to make a good investment decision but something out of left field happens and changes your initial investment thesis and you end up with a loss instead of a profit. In both cases, you need to focus on the fact that in the long term, a series of good decisions will always make you a winner in the end, whatever the short term results might be.
2- Emotions control is primordial and sometimes underestimated
When a poker player goes through a stretch of bad lucks, he can be prone to enter a mental state that we call tilt, which is basically poor decision-making due to a loss of control over his emotions. At that time, the player begins to think in an irrational way and to act impulsively. It’s a very dangerous phase in which any serious poker player must be able to notice what is happening and step away from the table if he thinks he’s not able to make good decisions anymore.
In the stock market, the daily fluctuations of stock prices are mostly based on investors’ emotions, who trade according to their spur of the moment. Technical analysis was built around that idea. The chart of a stock is actually a graphical representation of investors’ emotions throughout a period of time. Investors’ emotions can bring the price of stock to a point where it’s significantly different from its intrinsic value – for novices, intrinsic value is a theoretical concept and refers to the value obtained after a rational or fundamental analysis of the risks and future perspectives of a financial asset -. When an investor does the fundamental analysis of a company and takes the decision to buy it, he must be aware of his emotions and not let them influence him when the price of the stock fluctuates. It’s when they listen to their emotions that a lot of novice investors (I’ve done it too) end up buying a stock at its peak after a long run up, just to see it crash in spectacular fashion a few days or weeks after, or sell a stock at a loss to see it make a miraculous come-back right after. I sincerely believe that emotional control and discipline are among the most important elements to improve, for the poker player as well as for the stock market investor, and it is too often ignored.