Poker and Stock Trading Psychology Part Two

Part One said, “Almost everything written about poker psychology is based upon anecdotes and opinions, not scientifically acceptable data… 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…

“Because they have rigorously studied so much data, behavioral finance is far ahead of poker psychology…

“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.”

Behavioral Finance’s Foundations

Its foundations include:

1. Well-controlled experiments by psychologists such as Tversky and Kahneman

2. Surveys and other non-experimental research

3. Analyses by psychologists and non-psychologists of financial data

4. Analyses by psychologists and non-psychologists of investors’ decisions
The best (but somewhat dated) source for numbers 1-3 is James Montier’s Behavioral Finance. Many investors (including Warren Buffet) and Dr. Steenbarger, a psychologist and trader, have written about number 4.

Poker Psychology’s Foundations

Its foundations include:

1. Social scientists analyze online poker hands. Ingo Fiedler and other economists have been doing it for years, and a psychologist, Ann-Christin Wilcke, recently analyzed hand histories of poker players for evidence of different forms of chasing. Other psychological studies are inevitable.

2. Dr. Tricia Cardner, Dr. Soledad Espinola, and others study successful professional players’ characteristics.

3. Aaron Weinstein and others apply sports psychology principles to poker.

4. Psychologists such as Arthur Reber, John Feeney, Jared Tendler, James McKenna, and I apply psychological research to poker.

5. Perceptive non-psychologists such as David Sklansky, Mike Caro, Joe Navarro, and Doyle Brunson provide psychological insights (which are often better those of psychologists).

This series uses these sources to understand how and why traders and poker players make similar, costly mistakes.

Optimism and Overconfidence

Montier discussed them on pages 1 and 2 of Behavioral Finance: “Perhaps the best documented of all psychological errors is the tendency to be over-optimistic. People tend to exaggerate their own abilities… they are overconfident as well.” These two traits cause many costly mistakes, including:

Choosing the wrong games

Over-simplifying the games

Playing too many hands

Chasing too much

Choosing the wrong games: Mason Malmuth wrote: “Once you reach a certain level of competence at poker, your most important decision by far is game selection.” (Poker Essays, p.122) You can’t win unless you choose games that provide enough edge to cover costs and yield a profit.

Many players essentially ignore costs. They don’t realize that small games’ costs are so high that they need a huge edge. As games get larger, relative costs (compared to the stakes) go down, but competition gets tougher. So they need a smaller edge to win, but it’s harder to have an edge against tougher players.

Because costs are less, traders need a smaller edge, but their competition is much tougher.

Overconfidence causes countless players to overestimate their edge. Roy Cooke said your edge depends, “not on how well you play, but on how well you play in relation to your opponents… This presents a significant problem… almost all players put themselves closer to the front of the pack than they deserve to be.” (“A Great Game?” Card Player, 5/10/2002) Therefore, optimism and overconfidence make many players and traders choose games they can’t beat.

Over-Simplifying the Game:

Optimistic, overconfident people think it’s easy to win. Television infomercials claim that a short course will teach novice traders how to make fortunes. Only fools believe such nonsense, but, since people buy these courses, there must be lots of fools.

Some poker books make equally ridiculous claims such as Awesome Profits: From Kitchen Poker Table to Tournament Final Table and Poker A Guaranteed Income for Life. As Mason Malmuth put it, “If you do not have a good understanding of poker’s complexity, it is easy to fall into what has been called the ‘magic formula trap.’” (Poker Essays, p. 23) Of course, there isn’t any magic formula, and believing in it causes stupid mistakes.

Playing too many hands: Many traders — especially novices — make far too many trades instead of selecting only the best ones. Beginners play far too many hands, but everybody occasionally plays cards we should fold. Since we make the play-or-fold decision every hand, this mistake is extremely costly. Why do we make this stupid, expensive mistake? Partly because we want action, but optimism and overconfidence are also important causes.

Optimism makes people underestimate their risks and overestimate their potential profits. “If I hit the flop hard, nobody will put me on 5-3 suited, and I can win a big pot.” Of course, they are much more likely to miss the flop or get a piece that makes them lose more money on later streets.

Overconfidence makes them overestimate their skills. Since they know that experts can profitably play marginal hands, overconfident people foolishly believe, “You can’t play these cards profitably, but I am so talented that I can make money with them.” So they play hands that wiser people would fold and take the losses they deserve.

Chasing too much: Optimism and overconfidence have the same sort of causal relationship to this costly and very common error. Players think their chances of winning are much greater than they really are and that, if they do get lucky, they will win more than they can reasonably expect. They are usually disappointed. They rarely make their hands, and, when they do, they may not get paid off or lose to a bigger hand.

Robyn Salisbury, a poker player and professional trader, said, “One thing that expert traders do is lose less when they are wrong. … this is similar to a very good poker player who gets away from a hand when he’s wrong.”

Overconfidence adds to the belief that they will get paid very well if they make their hand. They think they have played so well that their foolish opponents will automatically pay them off. Worse yet, they may foolishly believe that, if they miss, they can bluff successfully. They don’t see the contradiction between expecting to be paid off when they make their hand and expecting to bluff successfully when they miss. If fact, since opponents aren’t idiots, they are far more likely to be called when they bluff and to get no action when they make their hands.

We have seen that optimism and overconfidence are major causes for some of the most common and expensive errors. Future articles will show how other psychological characteristics cause traders and poker players to ignore the experts’ advice and make easily avoidable mistakes. ♠

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?