Thursday, May 21, 2009

Now, learn portfolio strategies from a game of stud poker

One of the best ideas for managing your portfolio on an ongoing basis is to treat each stock (or fund) in your portfolio as a hand in a game of stud poker. Not my idea. Peter Lynch mentioned it in his book: "One Up on Wall Street".

Stud poker is a 'man's game', pitting strong-willed men with nerves of steel and expressionless faces against each other across a card table. The game has been immortalised in several Hollywood films.

Two of them - my favourites - come to mind. The old pro, Edward G. Robinson playing against the new kid on the block, Steve McQueen, in "The Cincinnati Kid". And a sophisticated Robert Shaw being taken for a ride by a bumbling Paul Newman in "The Sting".

The game - for the uninitiated - is simple enough. A card is dealt face-down, which can only be seen by the player to whom it was dealt. This is immediately followed by a second card dealt face-up to each player. All players get to see the face-up cards. A round of betting follows. Each bet is for a specific amount.

A player has the option to 'fold' (i.e. take no further part, if the cards he has been dealt are not to his liking); 'call' (i.e. stay in the game by betting an equal amount) or 'raise' (i.e. increase the bet by a pre-determined amount). Every time a player raises the bet, another round of betting follows.

The process is repeated three more times, as a card is dealt face-up to each player remaining in the game. After all five cards for each hand have been dealt (one face-down and four face-up) and the betting is concluded, the players remaining in the game show their hands to the others. The player with the best five card combination wins.

I'm not a gambling man, nor do I advocate a gambling mentality in the stock market. But the analogy - that each stock (or fund) in your portfolio is akin to a hand at stud poker - seems very apt.

The face-down card is like some knowledge or information you may have about the company that may not be known to the general public. Each face-up card is some bit of financial news or company-specific information that becomes available in the market.

As each 'card' is dealt, you need to take some action as an investor. If it is pretty bad news - like the Satyam fraud, or Punj Lloyd's overseas subsidiary delaying a project and incurring a huge penalty - you should fold (i.e. sell) that particular hand.

If it is so-so or good information - like Larsen and Toubro bagging a new order, or Tata Investment declaring a marginal profit and matching last year's dividend - you may hold your stock (or fund).

If it is better news - like 3i Infotech declaring increased profits when most IT companies were struggling in the down turn - raise the bet (i.e. buy some more).

You'll need the mental and physical discipline of tracking each bit of information about each of the stocks (or funds) in your portfolio, analysing the consequences and filing it properly at a place from where it can be retrieved easily.

It is not rocket science, but it has to be followed diligently on a regular basis - at least once a week. That means not only tracking company results and announcements, but also the forex rates and macro-economic and political news to understand the implications and likely effects on your portfolio.

Many intelligent individuals never succeed in their market investments. A probable cause can be the lack of time and/or discipline in following a regular process of updating information about their portfolio holdings.

Life becomes a lot easier if you manage to limit your holdings to 10-12 stocks or 5-6 mutual funds. Keeping track of fewer companies improves your chances of being able to move quickly as the situation demands.

Weekly tracking of a smaller number of companies (or funds) means you will tend to remember the important bits of information necessary for taking buy-sell-hold decisions.


Eswar Santhosh said...

Do not know about C.Kid, but "The Sting" is a great movie about con artists. It's one of the few films for which I cannot remember the film without the music (Scott Joplin's "The Entertainer").

Aside, another analogy is for companies with shady promoters. Trust them without proper research, we could meet a similar fate as Robert Shaw's character.

Subhankar said...

Great point about the analogy of the fate of most small investors with the fate of Robert Shaw's character in 'The Sting'.

If you liked Joplin's ragtime music, then appreciating jazz will only be a hop-skip-jump away.

McQueen and Newman are two of my favourite Hollywood actors. Many of their movies are now available on VCD/DVD.

'Bullitt' featured a car chase through the streets of San Francisco that set a benchmark for car chases in films before computer graphics arrived on the scene. Lalo Schifrin's background music adds to thrill.

Eswar Santhosh said...

I remember that "French Connection" and "Ronin" had Car chases. Yet to watch "Bullitt".

BTW, 'Bullitt' was voted as the favourite car chase movie in a recent poll. Thanks for another movie recommendation.

Subhankar said...

Thanks for the link to the poll, Eswar. I'm not the least bit surprised by the poll result.

Keep coming back to this blog and you will find lots of little nuggets!;-)

Eswar Santhosh said...

Speaking of films before CGI became everything, I happened to watch "The Invisible Man" (1933). Though other effects like a car crash may look hilarious, the effects of the invisibility were really good, still is - because you know they did not have the luxury of green screens, wires and CGI back then.

Of course, one should have patience (or have the prior experience in watching very old films) to sit through 70 minutes :-)