Some readers may recall a column I wrote on May 3 of this year in which I discussed Annie Duke and her book “Thinking in Bets.” (A book I still highly recommend.)
A former winner of the World Series of Poker Tournament of Champions and the NBC National Heads-Up Poker Championship, Duke now writes and speaks extensively on how to make investment decisions, which is how I came to know her.
As Duke points out, most decisions we make are under uncertainty. They are heavily influenced by luck, or by hidden information. We fool ourselves into thinking otherwise.
Now along comes an article in the New York Times about Maria Konnikova. Konnikova decides to learn to play poker to better understand the line between skill and luck. More specifically about what she could control and what she could not. And like Duke, she also became a champion poker player with over $300,000 in tournament winnings.
Armed with a doctorate in psychology, Konnikova’s book, “The Biggest Bluff,” is ostensibly about poker but more importantly is about her desire to explore the interplay between luck and skill. There are few exercises as ready-made for such an exploration as the game of poker known as Texas Hold ’em.
Like Duke, Konnikova delved into the, “Theory of Games and Economic Behavior,” by John von Neumann and Oskar Morgenstern. This book essentially created modern game theory. (I highly recommend it to those with a quantitative bent.)
Konnikova was a bit shocked to learn that von Neumannís seminal book about strategy was largely inspired by poker. Von Neumann, a brilliant mathematician and strategist, wrote that poker represented, in Konnikova’s words, “that ineffable balance between skill and chance that governs life.”
Von Neumann believed if he could figure out how to disentangle chance from skill and thereby maximize the role of skill, while minimizing the malice of chance, he would arrive at the solution to some of life’s greatest decision challenges.
Over the course of a year and a half, Konnikova goes from a rank novice who does not know a straight from a flush, to an accomplished pro who makes it to the final tables in poker tournaments. (Note, she was not as successful at the game as Duke.)
In discussing stock selection, Konnikova references Nobel laureate Daniel Kahneman, who believes that the selection of stocks by mutual fund managers has a greater attribution to rolling dice than playing poker.
According to Kahneman, the successful fund managers in any given year are largely lucky; meaning they have a good roll of the dice. Meanwhile, there is general agreement among researchers that nearly all stock pickers are participating in a game of chance.”
Thinking like a poker player could well be an important way to minimize the element of chance in investing and heighten the element of skill. Every investor feels invincible when the chips are falling their way. Suddenly, their superb investment acumen has gained them entry into the winning circle of investors.
However, it is not about your reaction to winning, but your reaction to losing. Konnikova refers to Dan Harrington, a respected author of books on poker strategy. Harrington notes that everyone plays well when they are winning. The key is to implement self-control when losing.
The crucial element in Konnikovaís poker experiences is learning how to take emotion out of decision-making. As an analogy, Konnikova describes an experiment done by her graduate adviser, Walter Mischel.
A psychologist, Mischel conducted the famous marshmallow test, or delayed gratification test. One version had children in a room with a treat, often a marshmallow, which they could either eat right away or hold off, knowing their reward for doing would be a second marshmallow.
The marshmallow tests were conducted in the 1960s. Mischel then followed his subjects for decades afterward. He found that those who were able to hold off eating the first marshmallow fared better in life than those who lacked that self-control.
You might want to think about that the next time you find yourself carried away by the ebullience of Wall Street.
Lauren Rudd is a financial writer and columnist. You can write to him at LVERudd@aol.com. Phone calls accepted between 9 AM and 3 PM at (941) 706-3449. For back columns please go to www.RuddReport.com.