Poker And Stock Trading Psychology

Almost everything written about poker psychology is based upon anecdotes and opinions, not scientifically acceptable data. Before online poker, psychologists had hardly any quantitative data on the game. Ingo Fiedler and a few other economists have studied online poker data, but I don’t know of any psychological research about online poker.

Some behavioral finance studies can be related to poker psychology, and these researchers have analyzed millions of publicly recorded transactions. They can see exactly when, where, and how investors and traders bought and sold, then slice and dice the data to determine why they made these decisions.

Poker players resemble stock traders, not investors. Investors hold stocks for months or years, while traders buy and sell quickly, sometimes in only seconds.

Because they have rigorously studied so much data, behavioral finance is far ahead of poker psychology. In fact, a psychologist, Daniel Kahneman, won a Nobel Economics Prize. His collaborator, Amos Tversky, died too soon to share the award.

Prescriptions Versus Descriptions

Classical economists and poker strategists are prescriptive: How should people act? Behavioral finance researchers and poker psychologists are descriptive: How do people really act?

Objective observers of poker players and stock traders know that their actions are extremely different from the experts’ recommendations. James Montier wrote in Behavioral Finance, “The models of classical finance are fatally flawed. They fail to produce predictions that are even vaguely close to the outcomes we observe in real financial markets.”

The same principle applies to poker. Nobody always plays correctly, and many players rarely follow the experts’ advice.

Behavioral finance researchers analyze why traders make stupid mistakes. Which motivational, emotional, and cognitive forces make them act irrationally? Their research can help you to understand these forces, minimize their effects upon you, and exploit them against your opponents.

I’m following the lead of my Card Player colleague, the late Barry Tanenbaum. He and Prof. Rachel Croson applied prospect theory to poker to explain some common mistakes (Card Player Vol. 26, #20 & 21, cardplayer.com.)

Understanding and avoiding stupid mistakes are central themes of my books, especially Your Worst Poker Enemy. That title is very close to James Montier’s, The Little Book of Behavioral Investing: How Not to Be Your Own Worst Enemy.

The Myth of Rationality

Despite having better data, behavioral finance researchers have an unusual problem. Many economists, stock market analysts, and professional traders accept the rational man. He just wants to maximize his profits, carefully investigates all his alternatives, and always selects the best one.

Classical economists generally regard emotions, illogical thinking, and other motives as irrelevant. As Montier put it, “When economists talk to their brethren in other social sciences, they have a general tendency to be condescending, assuming that the study of man is a waste of time.” In the eleven years since Behavioral Finance was published, a growing number of economists have reluctantly conceded that “irrational” factors may affect decisions, but the classicists still cling to the myth.

Some economists, including a Nobel Laureate, even claim that heroin addiction is rational: “Rational addiction is the hypothesis that addictions can be usefully modeled as specific kinds of rational, forward-looking, optimal consumption plans … Kevin M. Murphy and Nobel laureate Gary S. Becker… tried to reconcile addictions with the standard rational choice framework of modern economics.”

Their position is nonsense, a desperate attempt to preserve the myth of rationality. They pretend that a fix’s short-term pleasure has greater “utility” than addiction’s long-term destruction. If we apply the same “logic” to poker, the compulsive gambler who loses everything is acting rationally.

Serious poker players know that we play poker for many reasons, including relaxing, socializing, competing, and just passing time. We also know that emotions, denial of reality, and other irrational factors affect everyone. We even say, “Poker isn’t a card game; it’s a people game played with cards.”

Institutional traders admit that amateurs may act irrationally, but they, the pros, are profit-maximizing computers. They’re denying reality, a supremely irrational action. As Montier put it, “Perhaps the most frequent rebuttal I face from institutional investors is that the behavioral literature is best aimed at private investors. However, I hope to have shown that institutional investors don’t act as fully rational investors.”

In fact, rationality/irrationality is a continuum, not a dichotomy. Some people are more rational than others, but nobody is completely rational or irrational. Poker pros are more rational than amateurs, but even the best sometimes act irrationally. They show off with fancy plays, take it easy on friends or pretty girls, attack their “enemies,” blow off steam, relieve boredom, and so on.

To understand how and why you, I, and everyone else make stupid mistakes, you must dismiss the myth of rationality.

Negative Sum Games

In both trading and poker, the losers always lose more than the winners win because of the rake, jackpot drop, tokes, commissions, taxes, and other costs. Your results depend primarily upon:

Your relative skill: How well do you play compared to your opponents?

Your costs: How much do you pay to play?

If costs are low, you can win if you’re just a little better. The larger the costs, the bigger edge you need. If the costs are too high, Daniel Negreanu couldn’t beat drunken idiots.

Poker players have much higher costs than traders, and the smallest games have the highest relative costs (compared to the amount wagered). Despite having weak opponents, hardly anyone beats the smallest games.

As games get larger, players get tougher, and costs increase, but relative costs go down much faster than skill level goes up. The Bellagio’s $40-$80 game has much better players than its $4-$8 game, but costs less than one-third more. So the percentage of winners slowly increases. The largest games may have only one or two losers and several winners, frequently pros.

Because most games are small, experts estimate that 85-90 percent of all players lose. Studies indicate that, because traders pay much lower costs, between one-third and one-half of them lose.

However, small traders face very tough competition. In small poker games, you’ll almost always face weak players, but small traders essentially compete with the entire market, which is generally driven by professionals.

In addition to being more skilled, the pros have information and tools that small traders can’t get. It’s as if you played $1-$2 no-limit hold’em against Phil Ivey and Tom Dwan, and they used laptop computers with immense databases.

Worse yet, computers make an ever-increasing percentage of trades. They search enormous databases in micro-seconds and, of course, don’t react emotionally. Very few amateurs can beat that game.

Conclusion

Traders, poker players, and the people who study both can learn from each other. Some traders have a fatally flawed model and mountains of data, while poker players have a more realistic model and hardly any hard data. Future articles will discuss what we can learn from each other. ♠

Do you often wonder, “Why are my results so disappointing?” Ask Dr. Al, [email protected]. He has published five books about poker psychology, five on other psychological subjects, and is David Sklansky’s co-author for DUCY?