While it’s important not to gamble with one’s investments, there are some valuable lessons investors can learn from the world of gambling. When you boil it down, gambling and investing both come down to probabilities, risk and reward. Almost every form of gambling has at least one lesson for investors.
Let’s start with one of the most popular forms of gambling – poker. There are several lessons to learn from poker, especially when you get into the psychological aspect of the game. But for now, let’s just concentrate on two lessons we can learn from professional poker players.
The first thing to understand is the difference between a professional (and successful) poker player and an amateur player. Amateurs tend to focus on how much they could win on any one hand, and will often keep betting to stay in the hand. Professionals view each hand as just one in a series of thousands of hands that will be played over months. They follow a strategy that they know will allow them to win more than they lose over the long term. They also know that anything could happen on a particular hand or on a given day – but that over time their strategy will pay out.
The second lesson follows on from the first. In order to keep playing thousands of poker hands, professionals will never allow themselves to lose so much in one game that they are ruined. They will only play in tournaments they can afford to play in because they know they might earn nothing for several tournaments in a row. They expect to win a tournament every few months, but to do so, they need to preserve their capital to keep entering more tournaments.
Investors need to think in probabilities, and there’s no better way to learn to do that do that than by studying casino games. These things take practice. The Oddschecker site links to several online casinos with free, no-deposit offers – a tactic useful for those new to using online casinos.
The first thing to do when playing any casino game is to figure out the odds. To do that, you need to understand the game and all the permutations. If you can’t figure the odds out, you should stand aside until you do.
Betting odds reflect the probabilities of one or more outcomes. Probability is one of the concepts that underpin all of finance and investing. Every investment or bet has a probability of paying out and a payout ratio (or risk-reward ratio.) If you multiply the risk-reward ratio by the probability of success, you get the average expected return. That’s what you will earn on average over a long series of investments or bets, but only if you stick to the strategy and the rules of the game don’t change.
Successful investors and gamblers both learn to think in terms of probability. They see each bet (or trade) as part of a series of bets, rather than an individual event.
In 2017, famed bond investor Bill Gross shared some investing lessons from the world of blackjack. The main takeaway was risk management. By playing blackjack, he realized just how small each bet needs to be to ensure long-term survival. Even the best blackjack players in the world can have long losing streaks. They know that eventually, their fortunes will change, but if they go broke before then they have no chance to recoup their losses.
Most investors take far too much risk on each investment. Even an investment that you perceive as having low risk can go wrong. While a blackjack player can only spread their risk over lots of hands played over a long period of time, investors can spread their risk across multiple markets and asset classes.
Gross played blackjack during the 1960s when very little research regarding the game’s probabilities had been published. He realized that he could gain an advantage by doing his own research and modelling the outcomes of each hand.
One of the reasons small-cap stocks tend to outperform large caps is that fewer analysts cover these stocks. Several famous investors have made a fortune by doing research on companies no one else was looking at. Once a company has been ‘discovered’ by the market, its share price will often reflect all available information. On the other hand, smaller companies that have been overlooked can offer far more upsides – provided of course that the analysis is correct.
Betting on a horse race is similar to investing in that the odds – which is the price you pay – are determined by the crowd, and not necessarily by the horse. Share prices are also determined by the crowd first, and a company’s fundamentals second. If the market expects great results, then that will be what the price reflects. If the company delivers results that are good, but not great, the share price will probably fall.
To win money betting on a horse race you need to bet on the horse that has a better chance of winning than the odds suggest. If everyone is backing a particular horse, it may well win, but the payoff will be low. The horses that are ranked second or third may not win very often, but the odds are more likely to be mispriced.
As an investor you should be looking for the shares that are priced for weak results, but where the results could be better than the market expects. This insightful article lists some other valuable lessons from the world of horse racing.
The roles played by sentiment, emotion and crowd psychology in sports betting is very similar to the roles they play in the stock market. Just like people tend to become emotionally attached to football teams, investors can become attached to their favorite shares.
Very often in the lead up to a football World Cup, people will tend to bet on their own national team out of a sense of patriotism. That means the odds in each country will be heavily skewed to the national team, regardless of the team’s chance of success.
The same thing happens in the stock market when investors tend to back the companies they like or the companies that have made them profits in the past. To really be successful at investing or sports betting, we should start out with no favorites. We should also consider the fact that the best investment or bet is probably something we don’t know about yet.
By studying various forms of gambling, we can gain a lot of perspective about what we are actually doing when we invest in a share or other investment. Firstly, we need to understand probabilities and understand that, to succeed, we need to think about the long terms and not obsess over each individual event. Secondly, we need to understand if and how the crowd affects the odds or price. And finally, we need to manage our risk so that we live to fight another day.