Warning: This is a High Risk Post … it’s only for those poor misguided souls who INSIST on speculating (be it: stocks, real-estate, FOREX, commodities, etc., etc.) … don’t do it! But, if you MUST try to gamble your way to a fortune (admittedly, it has – albeit RARELY – been done), at least read on ….
I have a confession to make: I love playing poker.
I had never played a hand – nor gambled at all (I hate any game where the casino odds are even 1% or 2% against me … why throw money away?!) – but, then I arrived in the USA and turned on the television just as Chris Moneymaker was bluffing Sammy Farha on his way to making history at the 2003 World Series of Poker …
… it was like meeting the eyes of a woman across a crowded room; it was (I am ashamed to admit) ‘love’ at first sight 🙂
Which brings me to the Universe’s Cruel Joke, and it goes something like this:
I exclusively play No-Limit Texas Hold’em but met a friend who is one of the world’s top Pot Limit Omaha pro’s … in fact, I now take tennis lessons with him. This (not him!) convinced me to give the game a try, so I throw $40 (being sensible, no need to throw ‘real money’ away) into an online table while I’m chatting to a friend over the ‘phone and what do you know, I’ve made $200 about 3 minutes later!
This is a game I could grow to love, so I proceeded to lose $4k over the next few weeks, playing my usual limits …
… oh, I know this is just ‘variance’, because I’m in with the best hand almost every single time 😉
Which brings me to Josh:
Josh is one of our 7 Millionaires … In Training! and he intends to make his money trading according to a system that he has been developing for trading pharmaceutical stocks. I have high hopes for Josh, and he will probably end up with his own hedge fund, if he survives his good luck.
You see, Josh has just hit it big – and sudden – as, he explains:
My net worth increased over 1200% on May 7. Check out my networth profile I updated recently.
[I put] the whole 401(k) and personal brokerage account into a penny pharmaceutical stock, (avg price was around .0475 cents.) Today it closed at .82 cents. The stock is TTNP, Titan Pharmaceuticals.
Adrian, when are we starting MM-201, I’m jumping out of my skin here?
As I said to Josh:
If you MM201′ed any harder, you’d burst
You see, it’s easy to make money when you find a stock that climbs straight up like Jeff’s Hornet on full after-burners, it’s MUCH harder to:
a) Repeat until rich, and
b) Keep it, once you’ve made it.
What has this to do with poker? More importantly, what does poker have to do with investing?
Well, if you are a trader/speculator … everything!
You see, poker is a high ‘variance’ activity – that means that there is both a skill and luck component – but, you may know this as high risk / high reward. And, the best friend of the professional poker player is not skill … or even having luck on their side … it’s bankroll management.
At its simplest, ‘bankroll management’ means not allocating too much of your bankroll (i.e. capital) to any one session, and walking away when you lose that … at its most complex, it can involve a whole set of rules, such as Chris Ferguson’s poker bankroll management system …
… Chris is a top poker professional who – as his own ‘grand experiment’ – set out to make $10,000 starting with just one penny. Even though he had great skill – far greater than any of his opponents at the levels that he was playing at – he knew that he needed to protect himself from that devil known as ‘variance’ (i.e. sheer bad luck):
Here’s how he did it:
Starting with nothing but a Full Tilt Poker account, Chris played in Freerolls until he earned enough to graduate to games with real-money buy-ins. From that point on, he adhered to a strict set of guidelines to build up his bankroll:
- He never bought into a cash game or a Sit & Go for more than 5 percent of his total bankroll; the only exception was at the lowest limits: he was allowed to buy into any game with a buy-in of $2.50 or less
- He didn’t buy into any multi-table tournaments for more than 2 percent of his total bankroll; the only exception was $1 MTTs
- If at any time during a No-Limit or Pot-Limit cash-game session the money on the table represented more than 10 percent of his total bankroll, he had to leave the game when the blinds reached him
Getting started wasn’t easy. In fact, it took more than seven months of steady play until he got his bankroll to stabilize at about $6.50. Undaunted, Chris maintained his discipline and dedication and continued with his challenge. Then, on November 26th, 2006, Chris made a major breakthrough. He turned a $1 tournament buy-in into $104 in prize money when he finished second in a 683-player tournament. Even with that huge bankroll boost, it still took Chris nine more months of hard work to reach $10K. But because he strictly adhered to the bankroll management strategy that he’d set for himself, Chris achieved his goal the following September.
Besides the sheer similarity in Josh’s and Chris’ graph, there are clear parallels between poker and trading … if you still can’t see them, stop and play a little $1 / $2 no-limit hold’em online … you’ll begin to see my point, pretty soon 😉
What has this to do with personal finance??!
Well, for traders and speculators,’bankroll management’ – which we call Making Money 101 – is also the most important skill that you need to learn so that you have a base to work from and a fall-back …
… if you are still not 100% convinced, I would encourage you to grab the book about Jesse Livermore – The World’s Greatest Trader. I want you to see that he became rich and broke FOUR separate times (then, blew his own head off) … I don’t want this to happen to you.
Once you really FEEL this, read on – otherwise, just bookmark this post and wait … nothing produces discipline better than the inevitable major loss …
OK, if you are now TRULY ‘on board’, I want you to break your ‘windfall’ into three easy (well, equal) pieces:
1. Trading Account: do more of what you just did, and hope to repeat (just remember NOT to put all of your position into one investment … ONLY invest into one ‘event’ what you would be happy to lose 100% of without suffering unduly)
2. Passive Investment Account: Buy a rental; or buy/hold ‘boring stocks’ that you would be happy to own forever … fight the urge to trade these stocks!
3. Savings Account: This is what you live on (assuming trading is your major source of income), keep this in cash or CD’s. I told Josh to use this as a deposit on his own condo.
When you lose 1. (almost all poker players – and traders – lose their ‘bankroll’ at least once in their lives … some MANY times a.k.a. Jesse Livermore) forget about ever ‘dipping’ into 2. or 3. to try and ‘catch up your losses’ … it won’t happen(!): you will simply have to go back and build up a new trading account from scratch … just like you did when you first started out.
Always remember this ‘3 easy pieces’ approach to windfalls and you won’t ever go [completely] broke …
Rich 1; Broke 0; Head [Intact] – not a bad scoreline
Adrian, great post.
Your, right; trading IS like poker because at very specific times you need to make an important calculated risk move when the odds are greatly in your favor. Sometimes these opportunities appear in poker, sometimes they appear in the stock market.
For example, when you hold pocket 7’s and two seven’s appear on the board, and there’s no chance of a straight flush…it’s time to maximize your profits, (hopefully the other guy makes a full house).
In stocks, you identify a great company, (thats the quad seven’s) and when it starts to tank for obvious short term reasons (this is the other guy landing a full house), it’s time to go all in, or at least half way in…
That is a lot that ties poker to business. I have played a lot of poker in my time. An I am happy to say that I am way up. Poker is much more about skill than most people think but the skill is not obvious. I am happy to say that now when I sit at a table over 80% of the time I get up a winner.
I have played very little on line poker, I much rather play with real cards and real chips. Poker has many lessons for the business person. One good lesson is to not take it personally when things go bad, it usually was not something that you could control, you need to shake it off fast and keep going. When my business had problems this was probably the best of all the poker lessons.
Unfortunately, as long as the odds are against you, the best bet is making one big bet than many smaller bets. This is provable mathematically, but I will refrain from doing so and boring everyone! Consider this- the odds are in the house’s favor and don’t they do everything they can to encourage you to play more?
I would argue that the odds for Chris Ferguson winning are actually in his favor because he has skills that improve his odds- unless he was only playing with other champions with similar skills as part of his challenge.
When the odds are in your favor the mathematics predict more smaller bets should result in a better outcome.
You won big- now consider do you need to take huge risks now? If you can reach your number conservatively from now on, why not do so and sleep well at night?
@ Rick – I believe that Josh will need to continue making some ‘big bets’ in order to reach his Number, but that may or may not involve 100% of his trading portfolio in future … and, I hope the takeaway from this article is that he will NOT trade 100% of his total cash / 401k in future! 🙂
Rick, I never lose sleep over investing. It is important to feel no emotion while trading and fear is the worst one to have. If your losing sleep, your afraid, and your going to make bad decisions.
Adrian, there is wisdom in following that rule during regular practice, but sometimes the opportunity is so obvious and risk so low, I would go 100% 401k and 200% brokerage, it all depends on the situation.
This is uncanny , that you mention poker this week. I just watched a poker tournament on t.v. this past week. There was a guy on there(considered one of the greatest players of all time) and he has won$40 Million playing poker) but with little discipline, he has also lost $40 million playing poker.
@ Josh – then ‘sometimes’ you’ll go broke 😉
Buy this book and read it , not for the trading method but for his life/death: http://www.amazon.com/Jesse-Livermore-Worlds-Greatest-Trader/dp/0471023264/ref=sr_1_2?ie=UTF8&s=books&qid=1244000275&sr=8-2
@ Steve – Who?
Looks like you have changed your stance a little on diversification. [http://7million7years.com/2008/12/19/the-allure-of-diversification/, where you don’t recommend diversification due loss specialized knowledge and consigning yourself to average returns]
I’m interested why you made the shift…
@ Jeff – This is a great question! This may APPEAR to be a shift, but it’s not … ‘bankroll management’ is not the same as diversification; I am basically suggesting that Josh (and all those in the business of ‘risk investment’ or where the future income stream is not assured) start creating his own Perpetual Money Machine: that’s VERY different from the standard type of diversification that most financial advisers talk about.
@Josh. Titan is levelling out – I would recommend you withdraw the original sum but leave the current profit in to fly effectively for free. “Easing out” I think they call it: a marvellous place to be, where you can grab your original investment capital back so it will be safe to use in another opportunity on another day. Well done.
From an idea I read in “Trading in the zone” by Mark Douglas – Amazon link:
When trading futures, his “easing out” method is to trade 3 contracts.
When the price moves 3 ticks in your direction you cash out one contract to quickly take something out of the market.
When the price moves enough for you to take out your entire original investment, you cash in the second contract.
Then any move in your direction thereafter is pure profit with no downside as you’ve taken out all the original money already. And if it tanks, you’re similarly unbothered.
A clever approach which lets you actually see some of the cash back in your wallet when things have gone well, so you’ll never wake up one day and cry because the entire amount is invested when it tanks.
KC, my fundamental strategy couldn’t be more different, I stay in until it doesn’t make sense to any more, then I get out. The fundamentals say to hold on for a while longer.
Couldn’t help but contribute this to the conversation. This is a quote from a conversation between Jack D. Schwager, author of “Market Wizards” and Gary Bielfeldt, a master trader.
“Could you explain your analogy between trading and poker?”
“I learned how to play poker at a very young age. My father taught me the concept of playing the percentage hands. You don’t just play every hand and stay through every card, because if you do, you will have a much higher probability of losing. You should play the good hands, and drop out of the poor hands, forfeiting the ante. When more of the cards are on the table and you have a very strong hand – in other words, when you feel the percentages are skewed in your favor – you raise and play that hand to the hilt.
If you apply the same principles of poker strategy to trading, it increases your odds of winning significantly. I have always tried to keep the concept of patience in mind by waiting for the right trade, just like you wait for the percentage hand in poker. If a trade doesn’t look right, you get out and take a small lose; it’s precisely equivalent to forfeiting the ante by dropping out of a poor hand in poker. On the other hand , when the percentages seem to be strongly in your favor, you should be aggressive and really try to leverage the trade similar to the way you raise on the good hands in poker.”
@Josh. Fair enough – you are following your own philosophy of trading and that’s great – I wish you luck, although from your success so far, you don’t need my wishes!
The only thing I would say is that when trading thinly traded stocks, it can be an interesting experiment to see the effect on the stock price of pulling some funds out.
I recognise that that is nowhere on your radar, which is fair enough, but other readers might benefit from being made aware by this comment that if you do a bit of selling after a ramp up, the way the stock price reacts can give useful guidance on how fragile the current price may be, especially in thinly traded stocks.
But I am fascinated by this poker approach, I will keenly follow its progress, bearing in mind that I personally am too nervous to not click the “Sell” button and not take a three-fold increase and put those winnings in my bank account.
I do hope your “poker nerve” does provide even better returns than I would have banked.
That’s the great thing about trading in the markets – there’s such a wide variety of trading personalities, and your approach certainly improves the liquidity in the market, for which we all should be grateful.
Good luck – and thanks for introducing an interestingly less nervous approach to trading.
@ Josh – Since you shared your chart. it looks like it doubled again (coming off a bit now) … I wonder what would happen if you COMBINED Rule #1 strategies (for pricing and/or trading in/out) with your strategy?
excellent thought. I still haven’t read the book completely. I picked it up one day and the first few chapters were so much like Buffetology, I thought it was a waste of time (I dissected Buffetology twice). But if you think it could help, I’ll read it.
Just in case your curious, I moved about half the funds out of TTNP yesterday @ 1.35 and into another small cap drug stock. Diversification is in full effect.
“This may APPEAR to be a shift, but it’s not … ‘bankroll management’ is not the same as diversification”
Back in December you said:
“… don’t forget that I have been well diversified in almost every area that Rick mentions: multiple businesses; multiple RE investments in different classes (residential; commercial; single condos / houses; multifamily; retail; office; etc.); stocks (but, no mutual funds of any kind … and, I intend to keep it that way!) … but, I don’t recommend it!
I see two problems with this:
1. You spread yourself pretty thinly – you risk becoming a Jack of All Investments But Master of None … this lack of specialized expertise (which you can, of course, try and ‘buy in’) and focus can actually INCREASE your investment risk, hence DECREASE your investment returns, and
2. You automatically consign your returns to the mean/average – not all of your investments can perform as well as your best investment …. if you are comfortable with this ‘best’ investment (or, at least one of your ‘above average’ ones) surely you would put more effort into doing more of those?”
If there hasn’t been a shift away from your all-or-nothing approach to investing, how do you reconcile the above statements with your current recommendation that Josh only keep 1/3 of his investable assets in a Trading Account–with another 1/3 of his investable assets in a passive investment account (never to be broken into for trading) and the last 1/3 in a Savings Account for use as a fallback (also never to be used for trading). This sounds an awful like a diversification strategy to me…
@ Josh – LOL. Diversification [does NOT equal] bankroll management. Good Luck with both the new and the ‘old’ stock!
@ Jeff – Because Josh isn’t INVESTING he is TRADING / SPECULATING … which requires a strategy closer to that outlined in this series of posts (and, for similar reasons):
As to the 2 x 1/3 that Josh should have OUTSIDE of his trading account, the non-diversification etc. ‘rules’ of this blog apply … in other words, this is an EXTRA little piece of advice specially for those on speculative incomes. Thanks for highlighting the issue 🙂
“Because Josh isn’t INVESTING he is TRADING / SPECULATING.”
Looks like you have just changed the universally accepted defintion of investing to not include the purchase of stock. I thought only Robert Kiyosaki could get away with something like that…[http://7million7years.com/2009/03/24/why-get-your-knickers-in-a-knot-over-robert-kiyosaki/]
I think your advice to Josh is sound–it allows him the opportunity to achieve atypically high results, while protecting him if he doesn’t get lucky. In many of your previous posts you concentrated (I felt to a fault) only on the potential positive outcomes from an investment–RE, stocks, and businesses. In this post it appears you take into consideration the potential failure of an investment…and recommended a strategy that didn’t allow Josh to ‘focus’ all of his investable dollars into one asset, and also forced him to purchase other investments that provided him a safety net.
@ Jeff – If we wanted “universally accepted” outcomes, we would be reading “universally accepted” blogs 😉
This post explains the difference b/w ‘investing’ and ‘trading/speculating’ – but, only as I see it:
[Hint: it’s not ‘stocks’, but what you do with them that, to me, makes the difference]
BTW: I hope that Josh reads this; very nicely put, thanks: “think your advice to Josh is sound–it allows him the opportunity to achieve atypically high results, while protecting him if he doesn’t get lucky.”
This post is unsettling to me, not least because Josh and I share a name.
I too share an interest in speculating on the stock market. My friends like horse and sports betting but I find the markets more fascinating.
The poker analogy is compelling because sometimes being right ISN’T good enough. External factors can crash our party (straight flush, market panic) and if you can’t afford to lose the hand/bet, you shouldn’t have the money on the table as a speculative bet. I have learned this with small amounts but acknowledge I haven’t invested the time to educate myself (yet) like Josh seems to have.
My point is more eloquently expressed here :
Thanks for the link…I think I read that post before, but it was a good refresher on your definition of investments (assets that provide income, and are not relied primarily on for short term appreciation) compared to a classical definition of investment “[a]n asset or item that is purchased with the hope that it will generate income or appreciate in the future” [http://www.investopedia.com/terms/i/investment.asp]
I guess I’m curious why you do not consider ‘short-term asset speculation’ an investment…is it the risk/variance of outcome, the % chance of it actually going well, the similarities with gambling, a personal experience with asset speculation, something you read somewhere?
Just to sum up (since we’ve digressed into semantics over the last several comments), in your previous posts regarding diversification, you recommend ‘focusing’ your money into an investment (that provides income and/or that you do not rely on to provide short term appreciation), but when it comes to speculating (buying an asset that you believe will provide you short term appreciation) you recommend a more diversified approach in order to manage the potential downside. Did I get all of that correctly?
@Adrian. Further to your earlier comment:
“@ Josh – Since you shared your chart. it looks like it doubled again (coming off a bit now) … I wonder what would happen if you COMBINED Rule #1 strategies (for pricing and/or trading in/out) with your strategy?”
I’ve done a post over at shareyournumber showing the charts as they relate to “Rule #1” and Josh’s TTNP, with explanations of how to implement his favoured technical indicators on MSN Money.
Explanations and screenshots at:
Applying “Rule #1” to poker trades see:
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That is exactly correct, more or less it’s just that the tools of the trade are different. The lifestyle and ways of a trader is similiar to how poker players think.