What Poker Players Can Teach You About Investing In my study of successful traders, I've been struck by the number of traders who are also good poker players. David Einhorn, the founder of hedge fund Greenlight Capital, even once finished third in the World Series of Poker. Here's why... Those from traditional investment backgrounds focus on understanding the underlying investment - whether that's a stock, bond, currency or commodity. Poker players are far more aware of the risks each trade entails - and, by extension, the importance of bet size. Poker players instinctively see the parallels between trading and poker. They view trading as a "game" rather than an intellectual exercise in financial analysis. Poker players see each trade as a "bet" they place and a matter of "playing the odds." If they are dealt a bad hand, they throw their cards in. If they are dealt a good hand, they increase their bet size. Put another way, poker players focus on playing the hands they are dealt. As a result, they don't attach their egos to each bet they place. The Dangers of Being "Right" Traders like to be right. It affirms our intelligence and boosts both our egos and our brokerage accounts. But many dangers lurk in this approach. Consider the following case... Say you've found the investment opportunity of the century. It's a sure thing. You have $50,000 to invest. It's such a good idea that you decide to bet the farm. Your bet size is 100%. Two things can happen... No. 1: Your bet works out, and you triple your money. You realize that you are a trading genius. Or No. 2: Something unexpected happens... and you lose all your money. Here's a quick quiz... Which outcome is worse? You're probably thinking, "That's a dumb question! Losing your money is worse!" Here's why you're wrong... If you lose the first time around, you lose only $50,000. But if you win, here's what could happen... You think you're a trading genius. You borrow money to invest (invest on margin). Your friends give you money to manage. And you bet all the money on the next sure thing. Then that investment goes belly-up. In the end, you lose $150,000 (after all, you tripled your money the first time!)... all your borrowed money... and your friends' money as well. This scenario plays out more often than you realize. How to Stay in the Game and Become a Successful Trader Let me leave you with some rules of thumb for successful trading. - Always calculate the maximum you are willing to lose on a trade - and size your position accordingly.
- Set your stop price based on the specific characteristics of the stock.
- Never risk losing more than 1% of your capital on any one trade.
I personally have never risked more than 0.5% (one-half of 1%) on any one idea for any of the hedge funds I traded. So what is the poker player's most important "secret" to successful trading? Successful trading is less about being right all the time... and far more about sizing your bets to make sure that you stay in the game long enough to win. Good investing, Nicholas P.S. For even more secrets to successful trading, you should check out The Oxford Club's Private Wealth Seminar next week. The event is chock-full of insightful presentations and profitable ideas, and you can access all of them from the comfort of your own home. Click here to learn more. |
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