Three principles to invest by from an unlikely source
When it comes to investing, psychology is an important part of what we need to understand to be a good investor. When asked what are three of the best investment principles I follow, I would like to borrow the following investing rules to Puggy Pearson who was a world-famous poker player in the 1970s.
Poker shares many characteristics with investing: it combines a need to understand mathematics and probabilities, with an attuned sense of the psychology of your own actions and those of your competitors. That’s why some of the best investors are great poker players!
Although psychology is no substitute for genius poker math, it can add incredible depth to a poker game when it's used in conjunction with a solid poker strategy.
1. “Know thyself”
You have to be able to understand what you do right, when you get scared and when you make errors. We have to be aware of the feelings that influence our thoughts and motivate our actions. For example, the temptation of “getting on with it to the next idea” is a common mistake in this industry, but you must force yourself to pass and sit out if it doesn’t fit the criteria of a good opportunity and only aggressively go after the best ones. Conversely some people cut positions but leave a little for “hope”; or double down after losing. All these errors will lower your returns in the long run.
If you don't know yourself, it's going to be very hard to make money.
2. “Know the right side of a 60/40”
What that means is 60% probability of success (40% chance of failure) and a 40% probability of success (60% chance of failure) are actually very close together and sometimes almost indistinguishable. If you consistently get them around the wrong way, you'll lose a lot of money. Markets don’t give you many if any “certainties”. As investors, we try to put the odds in our favour through company research and modelling and make our move only once we find the right opportunity.
3. “Money Management”
When things are going wrong, know when to walk away. An important principle of money management is to minimise losses in losing investments and make a significant amount in successful ones. The more money you commit, the greater the possible reward and the higher the risk of losing some of that investment. In investing as well as in poker, being wrong and being early can look almost the same – your opponent can take a lot of money off you before you realise your mistake.. At Morphic, we also use a stop-loss strategy to mitigate greater losses when we are proved to be wrong.