Gambler’s Fallacy–An Investment Version

Gambler’s Fallacy has something to do with events and frequency.  You can read about it here.  My version of gambler’s fallacy is that people associate the statistical risk/reward relationship of poker with investing in order to justify playing poker because….”Hey, I am working because Poker is like investing.”

If you want to play poker, just play.

I wrote a while back about Andrew Beal.  He runs Beal Bank in Texas that, from all accounts, has a tremendous record. He is also a huge poker player.  You can read the book, Professor, Banker and Suicide King about his adventures in the high stakes world of poker.  It is an interesting read on poker, not much about investing or his business story, however.

I have two main problems with Poker and the tenuous connection to investing.  Given my limited Poker playing, I could be totally off-base here.

First: In poker, when you have the best possible hand, betting a lot does not get you much in return.  If you go all-in, inevitably, most will see that you probably have a good hand, and therefore fold.  That just doesn’t happen in the markets.  Unless you are moving markets with you investment positions, investing heavily when you have a great opportunity, will give you a great reward.

Second, Poker is mostly a closed-system.  There are 52 cards, and depending on how many players, you can calculate the odds of your success based on your cards and what others might have.  If you have 3 aces, you know what can beat you, and what can’t beat you.  You might calculate that there is one hand that can beat you and there is a 2% chance that your opponent has those cards.  There is mathematical precision in that calculation and it is accurate.  Your opponent may end up have the cards that beat you, but since there was a 2% chance, you understand that it was a possibility.

This is where my biggest beef with poker and investing lies.  Investors frequently use these precise probabilities and odds in investing, when I don’t see any evidence that this precision is justified.  Investing, unlike poker, is not a closed-system.  There are not 52 cards with X amount of combinations.  There are a multitude of possibilities with any number of different actors influencing those possibilities on a daily basis.  There is nothing that raises my BS indicator more quickly than the following phrase, “We see a 70% probability of a 40% appreciation in the stock and only a 30% probability of 10% downside, therefore the risk/reward is favorable.”  Where did these numbers come from–the dart board in the local bar?

Beware of the false gods of precision…

Since it is Super Bowl week, I thought I would share this feel-good story…”From parking cars to playing in the Super Bowl in under a month.”   See here.  What are the odds on that….?














More to Explore

Returns for Great vs. Bad Businesses

Munger and The Cattle Rancher

Munger’s ability to find great businesses is directly related to his ability to consistently discard bad businesses. He is excellent at inverting, and discarding the bad businesses as quickly as possible.

The Abominable No-Man and Bad Management

Some investors think a business is good, but know that management is bad.  These investors justify the investment based on the idea that the great price of the business is worth the bad management. This is akin to marrying a supermodel who is going to yell at you all day.  Whatever pleasure your eyes may derive from the marriage, your ears will endure a greater amount of pain in the long run. The pocketbooks of those partnering with bad management are likely to see a similar 50%+ decline in their net worth.

This Post Has 6 Comments

  1. Very much enjoy the blog.

    I agree on point 2. Lack of precision is an issue in comparing th two.

    However, I will disagree with point 1. I think you shouldn’t consider it on a hand-by-hand basis. Instead, consider the game itself, especially who you are playing against. If the others are your table are the equivalent of a Warren Buffett, then either limit your losses with a small buy-in and/or get up and walk away. However, if you’ve determined the players are bad, by all means up your buy-in and ask for the limits to be raised!


  2. I have recently read ‘The Tao Of Poker’ by Larry Phillips. I thought it was full of strategic thought relevant to investing.


  3. Well the most interesting point regarding Beal’s business acumen that you can glean from his interest in poker is that he became obsessed with it partially as a way to waste time when he didn’t think there were any good loans to make. Smart.

    1. Great point. I would love to learn more about him and his bank. Just not much out there.

  4. I like your blog but you are clueless about poker. I think it should be a criteria that no one should be allowed to use poker as an anology unless they have made or lost an amount exceeding their usual monthly income at a poker game sitting. You just won’t truly understand the game unless you’ve been through it on both ends. I also don’t agree that there aren’t lessons that apply to both poker/gambling and stock market investing. Some of the most important concepts that I like and try to keep in mind are, probability of ruin, proper betting size, bankroll management, and psychology of a good gambler. I also like the Kenny Rogers song/movie. 🙂

    1. Thanks for the comment, Seung. I also enjoy the Kenny Rogers song/movie. Also, Rounders, that’s a great one. The GEICO commercial with Kenny Rogers is also great.

      Agree with your point about my cluelessness on poker. I am probably going to keep it that way…for the protection of my bank account.

Leave a Reply


Close Menu