Sunday, September 30, 2007

He's a card player, gambler, scoundrel. You'd like him.

More than a few times when I've told someone what I do for a living, they've scoffed and called me a "professional gambler." And while I hope few people really think of Wall Street as nothing more than a giant casino, there is an inescapable link between investing and gambling. I have yet to find a trading desk where the betting action wasn't rampant. Hell, the most famous book about the bond market is titled "Liar's Poker" and features a story about John Meriwether playing a game of liar's poker for $1 million.

It isn't hard to see why a professional securities trader would have the same psychological profile as an avid gambler. You have to be decisive. You have to accept risk. You have to understand that luck will be a big part of your success or failure on any given bet.

I myself was very much into gambling on NFL games as far back as high school. While I never had a large amount of money on a game, and it was mostly just in the form of a pool among my friends, I learned a lot about investing and trading through gambling on football.

Focus on the primary factors, don't get distracted by secondary and tertiary elements. By this I mean, focus on which team is more talented than the other. Only if you think the talent level is very close should you start drilling down to stuff like matchups and weather conditions and minor injuries. Sometimes the secondary and tertiary factors can talk you out of making a good bet, or talk you into making a bad bet.

Same goes in investing. Focus on the fundamentals of a company. Only after you've completely analyzed the fundamentals should you drill down to things like technicals of the trading price or potential EPS surprises. The firm with better management and a better business model will win out most of the time, even if you completely miss-time the trade. Just as the more talented football team will win most of the time.

Filter out irrelevant information. All the time you hear about how this team has beaten that team 6 out of their last 9 matchups or some such. But in the NFL, non-division teams don't play each other every year. So 9 matchups might be over a 12 year period. Is there any relevance to the fact that the Raiders beat the Colts several times in the late 90's?

Similar crapola gets thrown out in the investment world. Back in 2000, I remember people claiming that technology stocks do well in recessions. So while every one saw the economy was slowing in late 2000, technology was supposedly a "defensive" way to play the recession. Mmmmm... didn't work out too well. The fact is that each recession plays out a little different, just like each boom plays out a little different. The economic fundamentals are never exactly the same. Just like the Colts are a very different team today vs. 1995, the economy is different today than the last time we had a recession.

Ignore the media as best you can. This is really a corollary to the first two points, because the media loves to focus of secondary factors and throw out meaningless statistics. Watch any NFL pregame show this Sunday. 80% of the talk will be focused on worthless banter about who wants it more or what stadium is tough to play in or which player is a great leader or who's mentally tough or who owns who or who is inspired by some personal problem or which coach is a genius or who's reeling from their last loss etc. etc. Remarkably little time is spent talking about who is more talented than who.

They'll also vastly overweight what just happened last week. If a good team starts 2-1 then loses in week 4, invariably there will be a story on ESPN about whether its time for that team to panic. Meanwhile if an average team starts 1-2 and wins in week 4, invariably ESPN will do a story about whether that team is a legitimate title contender. Especially if the average team beats a pretty good team. You just wait: this Sunday is week 4 and I promise you both stories will run on Sportscenter or one of ESPN's other NFL shows at some point this week.

The financial media is similarly obsessed with the recent past. Since the dollar has recently been dropping, there's also been a rash of stories in the press about how to play a falling dollar. Its possible articles like this have something to do with why retail investors are constantly getting whipsawed.

When someone like CNBC interviews a PM, they will invariably ask what stocks the PM likes "in today's market." Of course, CNBC means literally today's market. And yet if you listen carefully to the answer, the stocks and reasons often have little to do with today's market. Just the other day I was listening to Squawk Box and some PM said he liked pharma stocks because of demographic issues. Well that probably means the guy has been holding those stocks for years. Today's market? Very few PM's buy stocks or bonds based on where they think the market is going this week.

Forget about what's possible, concentrate on what's probable. Is it possible that the Rams will upset the Cowboys later today. Sure, its possible. Anything is possible. But if you go through the scenarios of what it would take for St. Louis to score that upset, you'll realize the odds are low.

Similar with investing. You can talk yourself out of good investments by over-weighting disaster scenarios. Investing and betting are both about probabilities.

When you lose, understand why you lost. Sometimes you are just unlucky. In fact, you'll wind up being unlucky a lot if you hang around either the investing or sports gambling game long enough.

So when you make a bet or a trade that doesn't work, first figure out if you were just unlucky. If whatever went against you was a possibility you considered, but estimated to be a low probability, maybe its just an example of things not breaking your way.

Remember that the point of examining your mistakes is to learn from them. So don't stop at small picture reasons why the trade didn't work. Often times the more specific your reasons the less applicable to other trades. Take Enron. You could conclude that it was just fraud. But that's not too applicable to other trades, because fraud is extremely hard to detect. Or you could conclude that you need to look harder at off-balance sheet funding. Better. But even better would be to watch out for aggressive management. The more aggressive managers are more likely to push hard for better quarterly numbers. The harder they push, the more tempting fraud becomes.

Don't get lured by the big spread. Whether its a team favored by 16 or an A-rated bond with a 250 spread, it can be tempting to conclude that the spread alone makes the bet worth it. That kind of thinking leads to lawyer analysis. Lawyers are charged with representing their client, and therefore they gather and/or interpret evidence which supports their client's position. The truth isn't a lawyer's problem. People all too often make betting decisions with a conclusion in mind at the beginning, then overweight evidence that supports their decision and ignore contradicting evidence. What a great way to lose money!

Remember the point is to make money, not to be a hero. People love to make bets that, if they pay out, make the better look like a genius. But usually these bets are highly risky. Like taking the 30-1 shot to win the Super Bowl or betting on an 11 point underdog to win outright. Or buying a deep out of the money option. Or buying a bond with a $50 price. If you want to make a bet like that, fine, but make sure you are doing it because you've completed an exhaustive analysis. Not because you want to be a hero.

By the way, I like the Bears laying 3 this weekend.

Fair disclosure: I have the Bears laying 3 this weekend.


Anonymous said...

thanks for sharing the tips. do you actually write down your mistakes/analyze them?

Accrued Interest said...

Absolutely. I don't have time to get as into analyzing football betting anymore though. But trades? Yes.

Anonymous said...

I like to draw a distinction between "trading" and "investing".

A lot of my friends made all kinds of money - really, really serious, 'time to retire' money - on Tech stocks in the late '90's. I didn't make a dime and never had so much as a nickel in

The funny thing is, though, that my friends had exactly the same view on the ultimate success of these issues as I did - but it didn't matter to them, as long as market demand was there and likely to grow. On the other hand, I couldn't sleep at night if I knew I had a whack of cash in crap, even if it was crap that was going up.

And, of course, I don't mean to imply that everybody who claims to take a long view actually does take a long view when you look carefully. Some self-proclaimed asset managers don't know themselves very well.

'Trading' is a completely different skill set from 'Investing'.

Jeff said...

Nice discussion, similar to some of my past themes. I wrote and linked tonight at

Anonymous said...

That was a fascinating article...I'll bet you never get too angry over a losing trade, or too high on a winner. It takes discipline to keep a level emotional ground.

I, on the other hand, am generaly incapable of that level-headedness. I'm certainly more on the "gambly" side of things (although I DO know the difference between gambling and investing...when I gamble on sports, I don't really expect to win, I just like to play).

As a gambler, when I invest, I need discipline forced upon me -- a system, with rules, that I have to follow. I've been semi-successful with a number of rules-based day-trading programs...but as a sports-lover, there are now options out there as well.

I've gotten quite excited about should peruse that site if you haven't already. It makes you follow its "system", using sports gambling as the "investment" medium.

Kind of boring, actually, but surprisingly effective. I watched it for 9 months before taking it up.

Accrued Interest said...

James: I agree with you on the distinction. I muddled it in this post. From my seat, I'm charged with "trading" in that my turnover is around 70%, but the core decisions are all "investments" in that they are supposed to work out over a 6-12 month time period.

Ben: Discipline is the key to investing or trading. And its hard to maintain sometimes. Especially in the corporate bond world, where your downside is so large. Sometime I'll write about discipline. I'd say most of the people I admire in this business still need to have some level of external discipline forced on them. Like they set a few hard and fast limits on themselves in terms of size of bets or some such.

Anonymous said...

Very interesting post and it has cleared my mind up on a few issues. I tend to follow the sports markets but get so worked up about what other writers and tipsters say it sends me into a spin.

For a long time I have not been confident in my own abilities and following evidence which is out there as fact. Too often I read what others say about an event and it does influence my decision making.

I think I've come to the opinion that many people write about certain issues, well, because they have to write something. They choose the easiest way most of the time because making risky suggestions (even if it represents value) can make them look a little silly.

Anonymous said...

Who do you like between the Bengals giving 7 and the Pats tonight?

Personally, I think the "talent" rule says give the 7.

Accrued Interest said...

I don't know why you'd care about my opinion, considering the Bears got killed. F. I also liked Philly giving 3. F. I did have the over on CHI/DET (45) which hit.

Anonymous said...

Ah, a compulsive gambler. Excellent.

Now, do you think the indices moved today strictly with carry money. Note the fall of the yen today.

I honestly believe NE will kill them. I don't know what the over is.

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