Over the past few weeks, I’ve been relaxing from the volatility of the markets by having game nights with friends and family. However, I’ve noticed that games exhibit the same characteristics that investors need to know to be successful at investing.
Some games, such as dominoes and Yahtzee, rely more on pure chance (the roll of the dice) rather than player skill. Games like poker, where variable bets and bluffing come into play, are another story.
Although deemed risky for novices looking for a quick buck, games like poker, when played by professionals, offer key investment lessons.
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Three in particular come to mind:
• Bet heavily when the odds are in your favor
Most investors seek the safety of a diversified portfolio of safe assets such as stocks, bonds and cash. That’s fine over the long term for most investors, who probably lack the time needed to understand the markets better.
But many individual investors also have a tremendous wealth of information that could give them an edge over time. This edge lies within one’s career, family, or social interests.
This is the strategy used by Peter Lynch, who would buy retail stocks based on traffic at mall stores. He essentially gained localized knowledge by doing so, finding which companies were currently “hot” (and likely to beat earnings estimates), and which were now passé.
With this kind of knowledge, the odds are heavily in your favor, and you should bet heavily.
• Recognize and prepare for outside factors
No matter how well prepared or well researched you can be as an investor, something can (and usually will) go wrong. Most professional gamblers ensure to always have a deep reserve, and to never bet more than necessary to win.
In investing, institutional movers, central bankers, and legislative changes can all wreak havoc on a portfolio in a matter of minutes. No matter how good your investments are going, there’s always the potential for some outside factor to send your winning streak into a losing one.
Investors who keep some cash on the sidelines and don’t overuse leverage stay prepared for unforeseen consequences.
• Don’t let your emotions get in the way
In many ways, it’s easier to see emotions come to mind in the world of gambling. Why? Because you’re facing your opponent. Sometimes you’ll see gamblers engage in self-destructive behavior to “punish” an opponent on a winning streak. Of course, that behavior only destroys oneself.
While you’ll likely never see the person on the other side of the trade (remember: For every buyer, there’s a seller), investors often let their emotions take the better of themselves.
During a decline, they may rush to cash out of fear when they can instead find bargains. During times of overvaluation, investors may continue to invest when they should start getting cautious.
Following these three rules won’t always be easy in a changing market. But when applied consistently, they’ll reduce the possibility of loss, the key to winning at investing over the long haul.
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