P a t H o l l a n d
Red
Joker
Rules
Hh
the 35 Rules of Gambling that all Investors Should Know
Red Joker Rules The 35 Rules of Gambling (That All Investors Should Know)
by Pat Holland
HARRIMAN HOUSE LTD 3A Penns Road Petersfield Hampshire GU32 2EW GREAT BRITAIN Tel: +44 (0)1730 233870 Fax: +44 (0)1730 233880 Email:
[email protected] Website: www.harriman-house.com First published in Great Britain in 2009 Copyright © Harriman House Ltd
The right of Pat Holland to be identified as Author has been asserted in accordance with the Copyright, Design and Patents Act 1988 ISBN: 978-19066591-72 British Library Cataloguing in Publication Data A CIP catalogue record for this book can be obtained from the British Library. All rights reserved; no part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise without the prior written permission of the Publisher. This book may not be lent, resold, hired out or otherwise disposed of by way of trade in any form of binding or cover other than that in which it is published without the prior written consent of the Publisher.
Printed and bound in Great Britain by CPI, Antony Rowe, Chippenham.
No responsibility for loss occasioned to any person or corporate body acting or refraining to act as a result of reading material in this book can be accepted by the publisher, by the author, or by the employers of the author.
Contents Biography Introduction Prologue Gambling is Investing Investing is Gambling
vii ix x xi xiv
Part 1: Parlays Concept: The Geometric Progression Rule 1: Start Early Rule 2: Never Offer an Unlimited Parlay Rule 3: Keep a Reserve Tank Rule 4: Never Chase Your Losses Rule 5: Stay in Your League Rule 6: Gamble Your Early Winnings Rule 7: Don’t Get Addicted Rule 8: Bid Boldly, Play Safe Case Study: The Club Bridge Gambler Case Study: The Bingo Gambler Case Study: The Roulette Gambler Case Study: The Texas Hold ’Em Gambler
3 5 10 12 14 16 18 20 22 25 27 30 32 34
Part 2: Pitfalls Pitfalls and the Power of Zero Rule 9: Never Bet Too Big... Rule 10: …And Never Bet Too Small Rule 11: Turn Down Proposition Bets Rule 12: Visit the Parade Ring
37 39 42 44 46 49
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Red Joker Rules
Rule 13: Don’t Get in Hock to the Bookies Rule 14: Keep Emotion Out of it Rule 15: Never Listen to Tips Rule 16: Watch the Dealer Rule 17: Don’t Bluff to Bluff Rule 18: Do Not Cheat Rule 19: Engage Mathematics as Your Servant, Not Your Master Case Study: The Craps Gambler Case Study: The One-Armed Bandit Gambler Part 3: The Plateau Concept: Making the Theory of Large Numbers Work For you Rule 20: Sessions Are Not Seasons Rule 21: Seasons Are Not Sessions Rule 22: Don’t Think of Gains or Losses as Spending Money Until the Game is Over Rule 23: Manage Your Money Rule 24: Set Targets Rule 25: Reduce Risks with Time Rule 26: Look for a Middle Case Study: The Blackjack Gambler Part 4: Percentages Concept: Percentages, Odds, Ratios and Probabilities Rule 27: Study the Form Rule 28: Turn Down Most Bets
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51 53 55 58 61 63 65 68 70 73 75 85 87 89 91 96 98 100 103 105 107 112 116
Contents
Rule 29: Small Percentages Are Big Percentages Rule 30: Study Your Opponents Rule 31: Beware of Long Odds Rule 32: Never Follow a Springer to Starting Price Rule 33: Never Bet Ante-Post Rule 34: Get to Know the Trainer Case Study: The Professional Racing Gambler Rule 35: The Ultimate Rule Epilogue
118 121 123 125 127 129 131 133 135
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Biography Pat Holland, B.Sc. has been a maths teacher and a recreational gambler for most of his life. Today he works as a freelance writer and takes an interest in the world of investment. He has long been interested in the common links between the principles of gambling and those of investment, and has been gathering the material for this book for many years. Pat Holland is married with three grown-up children, and is the author of three previous books and several thousand articles.
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Introduction 'Gambling is investing, and investing is gambling,' says the Red Joker. Both situations begin with a common pool of money. The pool is distributed among those who have created it on the basis of a series of events that are partly controllable. Through a mixture of skills, self-control and sheer luck, some of those who have created it will receive more than others. There is no inherent difference between sifting through a horse's prospects of winning a race and a company's prospects of returning regular profits. There is no inherent difference in deciding whether to raise the betting on a particular hand of cards and deciding whether a property is a good or bad buy. But there is a world of difference between the pace of gambling and the pace of investing. A gambler faces as many investment situations in a week as an investor does in a lifetime. The rules are the same, but the gambler is in a situation where he can learn the rules very quickly. This is a book of advice from the gambler to the investor The Red Joker Rules.
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Prologue The Red Joker sat at a plain wooden table covered in dust. While we watched, he wrote absent-mindedly in the dust with a finger as long and as pale as a candle. His tunic and hat blazed scarlet and gold. Tiny bells swung noiselessly from the lobes of his hat and the collar that covered his shoulders. His other hand moved stacks of what might have been old gold coins, or scarlet chips. ‘Enter,’ he said. He did not rise, but indicated that I should sit opposite him. ‘Red Joker Rules,’ he said. I sat down. ‘This is a rare honour,’ I said. ‘The Common Man does not normally get the chance to encounter the Red Joker.’ ‘You have encountered me every day of your gambling life. At every turn of a card, every photo finish, every rattle of the dice, I have been speaking to you.’ ‘I do not mean that. I mean face to face, the kind of interview you are about to grant me now.’ ‘Yes, I can see that such an interview is unexpected.’ The Red Joker smiled. ‘But, then, I would not be the Red Joker if I did not sometimes do the unexpected.’
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Gambling is Investing Common Man: Thank you, sir, for granting this interview. Red Joker: I decided the time was ready to expand on my oft-repeated statement that there is no qualitative difference between the processes of gambling and investing. And that the common principles can be more quickly learned from gambling situations than from investment situations. CM: So how should I address you? RJ: You could call me the Red Joker, the playing card that is an observer in some games and a live, disruptive presence in others. And whose long experience with gamblers places him in a position to offer advice. Or you could consider me to be some embodiment of the subconscious wisdom acquired by you and others over your gambling years. I prefer that you think of me as the spirit of gambling. The spirit you encounter every time you place a bet. The voice that speaks to you though you are not aware of it, the sum-total of experience and wisdom and emotion to be found in the gambling world. If war can have its Mars and love its Venus, why should gambling not have its Red Joker, especially as his essence transfers so perfectly to the investment world you now wish to enter?
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CM: I do not mean that. I mean, what should I call you during this interview? RJ: [slightly piqued]: Sir, will do very well. CM: Thank you, Sir. Let me begin by asking why we should concern ourselves with good gambling principles if they are the same as good investing principles? It just costs time. RJ: You are now in disagreement with a philosopher as great as Rousseau, who advocated that young men be given some money to gamble, as a fast way of learning the lessons of life. I also disagree with Rousseau because some of them will do nothing else for the rest of their lives. And ruin themselves. But the principle is correct. Gambling is investing. Consider a poker player who is dealt a total of 200 hands in an average session. For each of these hands, he will have to decide whether or not to risk money by playing it further. He is already an investor. He will further have to decide, on the basis of other cards dealt to his hand, whether he should raise the investment or write it off – perhaps half a dozen times in a single hand. There is no difference in deciding that a full house is worth investing in, or discarding – regardless of whether that house is three tens and two jacks in your hand, or a semi-detached for sale by a one-eyed retired night watchman in East Helsinki. - xii -
Introduction
Weigh the factors, commit the money. And because of the pace of gambling, the core principles become obvious much more quickly. CM: But gamblers lose and investors gain. RJ: I doubt that you would have been better off snapping up shares in Wall Street in 1929 than playing gin rummy under my watchful eye in a Brooklyn basement. But I take your point. There is a level of difference in that gambling operates on a diminishing pool of cash, eaten away by the profit margins of casinos and bookmakers, and that investing operates on an increasing pool of cash, expanding along with your progress as a species. A rough rule of thumb is that investment offers a positive return of 10% per annum over the long haul, and bookmakers offer a negative return of 10% or less. But that is not the point. The point is that the principles of good gambling can cut that negative return to almost zero, and failure to observe similar principles in investment will cut the positive return to almost zero. CM: Point taken. Can we move on to investment? RJ: Investment is gambling.
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Investing is Gambling Red Joker: We have established that gambling, however misguided and doomed to failure, is a form of investment. Have you any doubts as to whether investment is a form of gambling? Common Man: The gambling world is riddled with cheats and the investment world... [Pause] Gambling is a game of chance and investment isn’t. RJ: A matter of degree. The risk of losing money on an even-chance favourite is about 50%. The chances of losing money on the FTSE or on property are (usually) less, but they exist. CM: Gamblers have opponents. Investors do not. RJ: Everyone out there is an opponent. Anyone selling you an investment is an opponent, be he the broker maximising his fee, the seller looking for the best price, the developer trying not to go broke. The only distinction is pace. It is still a matter of everyone trying to maximise his or her share of the pot. Any further questions? [Long silence] Very well. There are differences in emphasis, and that will have some effect on the way I go about
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Introduction
presenting my rules. Many of them are already familiar to you but we must discuss how they apply to the investment world. We will also need to look at a number of case studies and draw lessons from them. I also subdivide my advice into four concepts called Parlays, Pitfalls, Plateaus and Percentages, all of them known to successful gamblers under a variety of names. As you have discovered, successful gamblers can be taciturn and cryptic about what makes them successful, and you will often be less wise after you receive their advice than you were before. So I will present a short introductory mathematical treatise to each of those four sections and then present the rules and case studies that relate to them. Agreed? CM: Yes, Sir!
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Part 1: Parlays
Concept: The Geometric Progression Red Joker: The parlay is a gambling term used to describe the practice of putting some, or all, of your winnings back into the pot. Incarnations of it include the Yankee, the Accumulator, the Double and the Treble. Professional gamblers abhor it and will be quick to tell you of its disadvantages. Nevertheless, the mathematical principal behind it, the geometric progression, is the first key to successful gambling. A geometric progression is formed by multiplying a startup figure such as 1, by another figure, such as 2. The resulting figure is then repeatedly multiplied by 2 to generate the sequence 1,2,4,8,16… ad infinitum. The formula is– Tn = arn-1 Where, a is the first term or bet, r is the ratio at which it grows per session, n is the number of sessions. Banks call it compound interest. To the novice gambler, this an attractive bet. By placing a £10 accumulator on a series of four even-money favourites
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Red Joker Rules
(wow, practically certainties!) he can walk away with £160 before the meeting is over. Professional gamblers know, of course, that the losing chances compound even more quickly than the winning ones, and they would not make such a bet. Those professional gamblers do use the geometric progression, but they do so in a controlled way and often without conscious knowledge of doing so. They also spend extended periods when they use the geometric progression so gently that it is barely perceptible. Common Man: Such as? RJ: The geometric progression is the route by which an amateur poker player notices the triangular fin sprouting from his back and becomes a professional poker player. He plays a social lunchtime game with his workmates in which the maximum bet is £5 and his personal limit is £100. Because he is such a better player than they are, he finds himself with £500 profit at the end of the year. He then joins a poker school where the maximum bet is £25. He is unconcerned about losing his windfall £500, he parlays it up to £5,000, and so on until he is regularly wagering thousands per hand. He is, in short, extrapolating a geometric progression where both the start-up figure and the multiplier are 5. And if he’s really good the figure keeps multiplying until he can’t find anyone rich enough to play against.
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Part 1: Parlays
The same applies to the professional racing gambler. And to any other field of gambling where great skill can overcome the odds. A much larger category of gamblers, the fun gamblers, who can keep their losses within their means, operates on a geometric progression where the multiplier is a figure less than 1. Take the figure 1 and repeatedly multiply it by 0.9, and you generate the following sequence: 1, 0.9, 0.81, 0.73… CM: Oh, we know this one. It’s the sum to infinity of a geometric progression where r lies between 1 and -1. You apply the formula S = a/(1-r). The total sum is always a finite figure, even if you continue ad infinitum. RJ: Almost ad infinitum, because after a while you come to a term so small that it is effectively zero. This is the format of the geometric progression used by professional gamblers when they hit a patch of bad luck. They cease to expand the amount of money they are willing to lose, and gamble on with lesser and lesser stakes. CM: So in the case of the poker player, he will return to the smaller schools and bet lesser amounts until his luck returns. In the case of the horseplayer, he will -7-
Red Joker Rules
reduce the value of his bets until he can build up his stake again. RJ: The great value of the geometric progression concept is that it expands winnings when things are going well, and makes it impossible to go broke when they are not. In gambling, runs of bad luck are frequent. In investment, less so, indicating that the geometric progression tool is the best the investor can have. You may also notice that whether you want to be, or not, you are already involved in two geometric progressions. One is inflation. Money is eternally losing its value because it is being multiplied down by an innocentlooking figure like 3.8% per annum. To counteract that innocent-looking figure, which is a gross rather than net writing-down of all the money in your life, you must find investments that pay better than, say, the 3.8% compound interest rate offered by banks. It is only a net rather than gross geometric progression writing-up of whatever money you manage to put aside. If you care, again, to apply the formula– Tn = arn-1 –to how a £100 investment yielding an average 10% per annum copes with inflation of 5% per annum over ten years, as follows...
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Part 1: Parlays
•
Investment: £100 multiplied by 1.1 raised to the power of 10 – 1 equals £259.
•
Inflation: £100 multiplied by 1.05 raised to the power of 10 – 1 equals £163.
You will see that the advantage grows even more rapidly with each year that passes. After ten years, you are better off by £96 and have effectively doubled your stake. After twenty years, you are even better off. And the disparity continues to grow. Oh, and another thing. A lot of investments are a similar race between two parlays, the interest rate on what you have borrowed to invest and the return from the investment. CM: So in summary, gamblers raise the stakes when things are going well and cut back when they are not, and successful investors must do the same. RJ: Exactly.
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Red Joker Rules
Rule 1: Start Early Red Joker: Successful gamblers start early. The Irish gambler, J.P. “The Sundance Kid” McManus, missed an important examination at the age of sixteen because he went downtown to back a sure-fire can’t-lose shirtswallowing racing certainty. Common Man: Needless to say, he lost both the race and the exam. RJ: It failed to stop him. He had started in time. By contrast, the gambler who arrives at the racecourse in a flustered state just as the horses are cantering down for the fifth race on the card isn’t going to win much. Even when his judgement isn’t impaired he can’t parlay his winnings upwards. And, of course, that once in a billion gambler whose twelve-horse each-way 10p accumulator wins him £254,638.18 wouldn’t have won it if he’d not been waiting outside the betting emporium before it opened. CM: The time to start investing is now. Right now? RJ: The fruits of the parlay cannot come your way unless you get in early. Investing is a lifetime thing. Don’t dither. At the very least, take advantage of the best pension or savings scheme your pay packet can afford.
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Part 1: Parlays
At best, if you are young (and, in our long-lived society, anything up to 60 is at least a little young) put some money into a solid long-term self-parlaying product such as an index tracker or an exchangetraded fund. Sure, the stock market is a volatile place, but the long-term maths indicates that a carefully chosen bundle will parlay up at a steady 10% per year. That puts it far ahead of inflation, and the difference grows all the time. You can, of course, expand your parlay much faster if you take to day trading, spread betting, and the other investment and gambling games. If you do, then reread the introduction to this section. It is important to pile up your winnings – but much, much, much more important to limit your losses.
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Rule 2: Never Offer an Unlimited Parlay Red Joker: Even the bookies run scared when a parlaybased bet gets through the early stages. A customer addicted to £10 each way Yankees on 10-1 chances, a walking bookmaker’s pension plan, transfigures to the spectre of bankruptcy when the first two come up. He’s already taken a sure £1000 and that’s nothing compared to the potential six-figure payout if the other two horses oblige. Common Man: Bookies get around the risk by setting house limits and by laying-off potentially dangerous bets with larger firms. The larger firms can absorb the occasional £100,000 loss and even get their money back in terms of favourable publicity. RJ: There’s a lot more of this around than you might imagine. You max out your 20% interest credit card but you’re about to go on holiday, so you arrange a 15% interest overdraft with the bank. The holiday is such fun that you max out the overdraft, too, and finish out the month on your girlfriend’s 20% interest credit card. You have now offered an unlimited parlay. The true rate of interest you are paying is at least 50% and rising. You will be trapped in this parlay for life if other debts slip behind. In investment terms, someone who mortgages his house, buys another to let out, mortgages that, buys
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two more, and builds up an empire also offers the unlimited parlay. CM: We know people who’ve done it. They are... RJ: They are shrewd, lucky, and unafraid of bankruptcy. They are also gamblers who happened to escape because the last horse in the parlay happened to fall and break his neck. Eventually, they either get out, drenched in sweat at their narrow escape, or go broke. Which brings us to the Reserve Tank Rule.
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Red Joker Rules
Rule 3: Keep a Reserve Tank Red Joker: Hand-in-hand with the concept of never offering an unlimited parlay goes the concept of keeping a reserve tank. Some gambling situations, notably in blackjack, craps, and the photo finish in racing, throw up situations where the best play unexpectedly calls for the gambler to raise his stake. In the photo finish situation, for example, the gambler may be able to totally insure profit on a race by betting on the horse which may, or may not, have beaten his choice. In Blackjack, favourable opportunities to split or go down for double may cluster and call for a raise of stakes. Common Man: We must, then, ring-fence a certain portion of our stake at the very beginning to take advantage of those situations? RJ: Yes, and you can continue to earn profits. In the investing situation, it is only necessary to keep part of your overall investment in funds that can be easily converted to cash. If all your investments are in stocks or property and you face either an unexpected opportunity or an unexpected disaster, you may have to sell them off for less than they are worth. CM: Or worse, go into debt.
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Part 1: Parlays
RJ: Where you may remain indefinitely and even be forced to leave the investment world forever. The advice, then, is to keep not less than 20% of what you can invest in deposit accounts, bonds, Post Office savings accounts, or anywhere that permits you to access the full amount at short notice.
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Red Joker Rules
Rule 4: Never Chase Your Losses Red Joker: Every gambler knows that you should never chase your losses. Common Man [wincing]: And almost every gambler, from time to time, gets emotional and does just that. I speak from experience. RJ: Chasing your losses is a phrase that describes the nightmare that can follow losing your stake on a series of races, hands of cards, or casino bets. You can walk away. You have partly turned on your heel and composed your features...but, no, you’re going to show the – ...you’re going to wipe the smile off their faces and get it all back in one big flourish. You’re going to stay on that last hand regardless of what you are dealt, and bet the limit. You are going to punish the bookies with the biggest C-note you can find in the housekeeping money. CM: Dark and deep and dangerous waters. RJ: Of course, you lose, and resolve to win it all back next week. And you don’t. The advantage lies with the enemy. You are on the wrong end of the parlay. CM: Surely investors don’t do that? RJ: Chasing your losses, or even your lower-thanexpected gains, is endemic among the more
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Part 1: Parlays
speculative kinds of investors. They lack that professional gambler’s patience. So when it’s not going as it should, unleash that professional gambler’s patience. Do NOT start trading like mad. Do NOT dump everything you’ve got in order to start again. Do NOT start using money you don’t have or can’t really raise. Do NOT start applying six-month tactics to your tenyear programmes. Unless it’s really Armageddon, let it sit. CM: And, if it is Armageddon? RJ: Take your losses. And start, modestly, all over again. I am not going to rummage about among the names of Johnny Moss, Jack “Treetop” Strauss, Pug Pearson, Doyle “Texas Dolly” Brunson, and all the others for a supreme, prime example of a great gambler who lost it all and had to start all over again. That is because they all are.
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Red Joker Rules
Rule 5: Stay in Your League Red Joker: You can be the best poker player in the world, but if you start to play poker at a level you can’t afford, three things will happen. Number one, the big players will be able to manipulate you into betting situations where you haven’t the chips left to make what you know to be the right play. Common Man: Number two, it will only take one run of bad luck to put you out for good. Nick the Greek was able to last five months in his non-stop 1949 poker marathon against Johnny Moss because he had the resources, enough to continue to manouevre in the $2.5m hole into which Mr Moss plunged him. If your reserve is $10,000, and Richard Branson draws his fourth jack to beat your house of aces, his $20,000 bet kills you off forever. RJ: Number three, you will be such a bundle of nerves that you will play less skilfully than usual. CM: This one’s obvious. RJ: Not so obvious that it doesn’t happen to investors a lot more often than it happens to poker players. You have no business trading in futures, or commodities, or spreads, if your funds are so low that a bad day can wipe you out.
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Part 1: Parlays
Not even if you are a billionaire. Even you poker players have heard the story of how Nelson Bunker Hunt went broke trying to corner the silver market. You cannot live for long beyond your means, and nowhere is that more true than in the worlds of financial risk, be it at the poker table or at the stock exchange.
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Red Joker Rules
Rule 6: Gamble Your Early Winnings Red Joker: Hobby gamblers or inexperienced gamblers are tempted to walk away from the game when they get slightly ahead. They have, after all, been given the price of a meal or a round of drinks for nothing, and it seems clever to enjoy it, rather than staking it back and feeling silly on losing it. And even a professional gambler who has hit it big early on can be sorely tempted. For the hobby gambler, it is good advice. For the regular gambler it is a loser. Common Man: You mean, like the Irish gambler J.P. McManus, who is noted for betting big when the early races go his way? His reasoning is that the bookmakers are anxious to win back what they have lost, and they fall into the trap of chasing their losses themselves. They make the odds more attractive to encourage you to continue. They, in effect, elect you to be bookmaker. RJ: That is a spectacular case, though not the one that best illustrates the point I am trying to make. The most convincing reason for gambling early wins is to enjoy the mathematical advantage implicit in the parlay concept. A study of Mr McManus’ entire gambling career, or indeed that of any successful gambler, will reveal that they continued to reinvest their winnings as they went along.
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Part 1: Parlays
CM: So, do not cash in too early? RJ: When the stock market is rising, when the housing market is going ballistic, there is a great temptation to cash in. There are situations (as we will see later) where you should. But it is generally true that any early gains from cashing in will look paltry a few years later – and, you may even get into trouble by developing looser spending habits or overconfidence in your new investments. CM: Let’s hope we encounter this problem a lot. RJ: There are endless investment situations where this maxim will help you. If you have the choice of taking or reinvesting your dividends, reinvest them. You might even deliberately choose investment vehicles that pay no dividends, or that automatically reinvest them. And, if you are following a policy of buying and selling attractive stocks annually or otherwise, resist the temptation to take a profit early on. Keep investing until your target exit time (early retirement, kids off to college, marriage) comes into view.
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Red Joker Rules
Rule 7: Don’t Get Addicted Red Joker: The greatest all-round poker player ever was Johnny Moss, who entered this world at the beginning of the 20th Century, and almost saw that century out. Adjusted for inflation, his winnings over an 80-year poker career would easily top £100,000,000 in today’s terms. What did he earn from his overall gambling career? Common Man: We’re supposed to guess? Okay. Want to have a bet on us getting it right to the nearest 10 million? No? Okay, invested at 5% interest and making allowances for a lavish lifestyle, let’s say £120 million. RJ: You would have lost your bet. Mr Johnny Moss was of modest means when he died. Mr Johnny Moss earned little from his gambling career because he was too keen on craps, the Las Vegas dice game where most of the odds are against you and the structure of the game tempts the player to ever more frequent, and ever bigger bets. CM: Every time Johnny Moss built up his poker fortune into the millions, he quickly lost it back at the craps table. RJ: He was not alone. Many otherwise successful gamblers have a weak spot for some game where they have no advantage. Poker players lose their winnings on the horses. Horse players throw it away on roulette. Bingo players pour their jackpot into the slot
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Part 1: Parlays
machines. Some gamblers, too, become addicted to the process of gambling. CM: The advice for them is simple. Get help. Get out. RJ: The increased pace of investment in this century, and the number of new investment vehicles where turnover is fast, is capable of turning every investor into a Johnny Moss. You can become addicted to the process or some aspect of it. Once you recognise that you, too, have an addiction – there are those of us who want to buy practically every house with the For Sale sign up, and those of us who can’t smell coffee without yearning to buy coffee futures – you must get rid of it. Remove that form of investment from your plans. If necessary get out of investing completely. Turn it over to an adviser or friend. CM: And there are real-life addictions. World Poker champion Stu “The Kid” Unger died in his forties while binging on cocaine. RJ: Real-life addictions impinge so heavily on the process of investment that your chances are poor unless you beat them. Cocaine does not make for sound judgement and few winners are to be found at the bottom of a champagne glass. You need to tackle those before you tackle the bulls and bears.
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Red Joker Rules
An addiction (the ever-increasing need for an everdecreasing pleasure) is a losing parlay. It will eventually leave you so broke that you have to quit investing for good. You have already given yourself the right advice. Get help. Get out.
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Part 1: Parlays
Rule 8: Bid Boldly, Play Safe Red Joker: This maxim comes from bridge. Common Man: I may require surgery to remove the expression of boredom from my face. I’m a gambler. RJ: I’ll have you know that rubber bridge, played for high stakes, becomes a full-on gambling game with poker tactics, including the bluff and the check-and-raise trap, making guest appearances. For those of you who are not bridge players, the bid is a competitive series of challenges issued by two teams of two players to take a certain number of tricks in a named suit. If they fall short, they lose points, but if they gain the predicted number of tricks they gain points. They also gain extra points for “games” and “slams” where they undertake to win all but one or two tricks of thirteen. Over the long haul, it is those players whose courage and judgement brings them to the most makable games and slams who will win. The late legendary Ladies’ World Bridge Champion, Rixi Markus, casually let slip near the end of her life that she ‘had won fortunes at rubber bridge.’ She was a notoriously aggressive bidder and a famously astute player. CM: I’m warming to this.
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Red Joker Rules
RJ: The lessons for investors are twofold. First, there is no payoff in placing a low limit on ambition. If your goal is to make a million before the age of 21 – as Aristotle Onassis did – you will almost certainly fall short. But the analysis, and the effort, and the sheer élan of following a “bid boldly” plan will probably make you a great deal better off than if you had merely put your money in a deposit account. CM: That’s just half of it. RJ: The “play safe” instruction comes into effect from the moment the first card strikes the table. Every possible aspect of the proposed investment must be studied and quantified. Warren Buffett studied investment opportunities for many years before making his move – which he does rarely. Until you know everything about the proposed investment, you must… CM: Play safe. RJ: …especially if, as happens in property investment, you can play an active role in how the investment works out.
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Part 1: Parlays
Case Study: The Club Bridge Gambler Red Joker: The Club Bridge Gambler has a walk-on part in Ian Fleming’s Moonraker. Moonraker is the novel where James Bond, the good guy, takes on Hugo Drax, the bad guy, in a game of bridge for five-figure stakes at The Blades Club. (Bond wins, but he is of no interest to this study because he wins by cheating.) Just before the game begins, M nods towards the Club Bridge Gambler and describes him in the phrase ‘real killer, wonderful card manners, makes a regular ten thousand a year out of the club.’ Common Man: This member should be as welcome as a slop-bucket crammed with piranhas standing where the Dom Pérignon on ice ought to be. RJ: Not so. There are enough players about who are willing to show off their wealth by losing to him. There are enough players willing to lose $10,000 for the pleasure of hammering him for $1,000 in one spectacular lifelong-bragging-rights hand. And enough rich players who see him as an aid to improving their bridge game and are willing to keep him in club fees and expenses for life. Meanwhile, he is the happiest man in the world. He is the man whose life is always a holiday, because his work is his play.
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CM: What has this to do with investment? RJ: The Club Bridge Gambler is a role model for the investor who knows so much about a particular aspect of life that he can trust his judgement in it. The artist who opens an art gallery. The motorbike enthusiast who collects classic models. The film correspondent who accumulates famous signatures. If you have a passionate interest in life, the odds are that you can become a successful collector or investor. You will continue to move in the same circles, but you will invest as you go. Just about anything is saleable or collectible. CM: We’re thinking of comics, cars, books, stamps, postcards, business signs, jewellery, furniture, and war memorabilia. RJ: There is an even greater advantage when your career forces you to acquire specific knowledge about a particular area of investing. A battery manufacturer becomes knowledgeable about the price of exotic metals that most of us haven’t heard about. Actresses know all about cosmetics. An experienced head waiter can walk across the lobby of a hotel and say with confidence that the chain is doomed unless it mends it ways. A farmer knows what’s happening to beef. Cat lovers know about pet services, dog lovers don’t know much about greyhounds but know a lot about dog food...
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CM: We should invest in what we know. RJ: That is the lesson to be learnt from the Club Bridge Gambler.
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Case Study: The Bingo Gambler Common Man: You cannot be serious. Red Joker: Bingo is a form of gambling. CM: No, it isn’t. Serious gamblers loathe and despise the Bingo Gambler. She’s the little old lady who ties her scarf beneath her chin and invests her winnings in Legoland and Teenage Turtles for the grandchildren. She takes no active part in her investing. She just runs about like a Cheviot Sheepdog doing everything she’s told. RJ [coolly]: Control your gambler’s snobbery. In one way, she’s the perfect gambler. Her stake costs her precisely nothing. It doubles up as her recreational money and costs her...nothing. CM: But, she’s terrible. She queues up to hand her money to a smooth-voiced smarmy-pants who does exactly what he pleases with it. What pleases him is to return no more than 50% of it to her. What really pleases him is to offer extra cards as her dexterity improves, so she can spend three or four times as much as she intended on it. And he’s absolutely delighted when she has a good run and decides to spend her winnings by visiting four nights a week instead of two. RJ: Recognise anyone? From the investment world, I mean, rather than the gambling world?
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[Long silence] CM: The laws of libel prevent us from naming names. So does lack of space. So does the bingo caller reading this piece who gets legal advice at having his basically benevolent operation appear in the same sentence as stories ending in the words ‘dubious practices in the days before the industry was as wellregulated as it is now...’ RJ: No investor can afford to run his investments bingofashion. Pension plans, managed funds, bank packages, any mechanical form of investment where the investor takes no active part, must be meticulously researched and analysed before touched with a barge pole. If it emerges that the true purpose of the fund is for the vendor to mount his personal parlay against yours, don’t touch it. Look for transparency, independent advice, and a flat and modest fee. Look elsewhere. That is the message of the Bingo Gambler. Never mark the numbers, as they are called, without finding out what lies behind them.
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Case Study: The Roulette Gambler Red Joker: Those who play roulette, night after night over the course of many years, come around to using some kind of a system. Most of those systems involve raising the stake after a loss and reducing it after a win. A simple example would be the Martingale – the term applied to doubling your stake after a loss. Common Man: Mathematically, that can’t lose. The player gains exactly one chip each time he wins. We can work out the formula, if you like. RJ: You can try it at the tables if you like. You will go broke when too long a losing sequence turns up, and you cannot make the next bet because the house limit has been reached. The Martingale system fails in practice. So does the Grand Martingale, the Labouchere, and even the very widely used Montant et Demontant – which involves raising the stake by one unit after a loss and decreasing it by one unit after a win. You can last for a long, long time on that one, but you will ultimately lose. CM: Not so bad, though? We like it. RJ [severely]: You are not trying to survive. You are trying to win. The Roulette Gambler, astute as he is – he has selected a game where the house edge is less than 2% and is playing it in a manner that spreads that edge
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over a long period of time – is losing. You must turn his systems on his head in order to win at investment. CM: Raise our stake after a series of wins and reduce it after a series of losses? RJ: Precisely. If I might use the Montant et Demontant example, the Roulette player will do better if he raises his stake after a win and reduces it after a loss. On the larger stage, the Montant et Demontant gambler is a good role model when things go well, things go badly, or your personal life takes you out of the investment scene for a while. Push your luck, but not too brashly, in the good times, and exercise caution, but not overcaution, in the bad times. Above all, do not fall into the twin traps of either walking away from the table, or risking everything on a single coup. No grand gestures, no great increases or decreases. Just Montant et Demontant. CM: The lesson of the Roulette Gambler seems to be to limit your losses, and let your winnings pile up. RJ: Yes.
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Case Study: The Texas Hold ’Em Gambler Red Joker: It took a hundred years, and at least a hundred experimental models, to convert the simple highest-cardwins game of poker into Texas Hold ’Em Poker. Two cards down, a three-card widow, another widow card, and a final widow card. The combination of focus, knowledge of percentages, patience, money management, observation of other players, coolness under pressure, and ability to bluff required to win, flower fully at Texas Hold ’Em. Common Man: Professional player and former world champion Pug Pearson said that he could turn a profit on the game without being dealt cards at all. RJ: It is a game where the best player inevitably wins. It also possesses a feature that, in other poker forms, is either insignificant or so obvious that any competent player can handle it – location. Location is all in Texas Hold ’Em. Cards only have value in relation to the other cards on the table. There are no sure-fire winners. Whether a player raises, calls or folds is determined by his location. CM [eagerly]: In relation to the last player to bet. To the player with the most or least money. To the beginning or end of the session. To the perception of each
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other’s style of play that he and the others have formed. RJ: Amarillo Slim’s maxim, that unless you can see a sucker (a weaker player) in the game, you should quit, because you’re the sucker, is the soul of Texas Hold’ Em. Do not play this game for serious stakes unless you are better than the other players. There are very few professional Texas Hold ’Em players, and no professionals who do not favour Texas Hold ’Em. CM: Correct us if we’re wrong, but the Texas Hold ’Em player is the gambling equivalent of the investor who sets out to build his own portfolio. RJ: He is, in particular, the equivalent of the investor who wants to build that portfolio fast, in the hectic world of futures, contracts for difference, day trading, property flipping, spread betting, and all the other make-or-breaks now available. To succeed in any of those areas you have got to be very, very good. Read through the gambling attributes in the second paragraph of this piece. Unless you are perfectly sure that you have all of them in abundance, fast fortune-building will not work for you. CM: I have all of them in abundance. RJ [smiling]: If you have those qualities, the first requirement is that you put in some practice. Play your chosen field with small stakes for a while, or
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play it mentally, making imaginary investments and watching how they work out. Oh, and know exactly how you will get back into the game if you go broke. Because you will, from time to time. Just as the card professionals do. You can’t plan your exit. You must plan your return. CM: The lesson of the Texas Hold ’Em expert seems to be that the greatest profit is to be made in managing your own portfolio directly. But only if you are skilled and knowledgeable and can negotiate the pitfalls. RJ: You are ready to hear about the pitfalls.
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Pitfalls and the Power of Zero Red Joker: How can something be a nothing, how can nothing be a something? Common Man: I don’t know, but I’m not going to invest in it or bet on it. RJ: Good. This lesson is now over. As you already understand what I am going to say, there is no point in me saying it. CM: Come on. Answer the riddle. RJ: It is not a riddle. It is a question posed by the Ancient Greeks about the concept of zero. Those marvellous philosophers were referring to the mathematical concept of zero, and their question has never been fully answered. The Ancient Greeks were consequently suspicious of it – and neither they nor the Romans incorporated it in their mathematical systems. In all our other little instruction sessions, I shall take a mathematical concept and show how it applies first to gambling, then to investment. Now I have a confession. In this session I am using the mathematical aspect as an analogy. Zero is the absence of a number, the lack of a number, nothingness. CM: That doesn’t sound very useful! - 39 -
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RJ: You would have as hard a time in handling your beloved odds, percentages, and probabilities as you would have going through life without a personal philosophy, if you did not have zero. (Try, if you will, working out the difference between eleven seventeenths and twenty-three thirty-eighths without decimalising them or making them percentages, both of which require a zero.) I will now make the point that zero is a vital tool, but that it does not really exist. And that its blind use will throw up unworkable situations, especially in the areas of multiplication, division, and indices. [Pause] CM: You pause when you know you’ve got us confused. RJ: If you multiply any number by zero, it will become zero, regardless of how large it was. If you divide any number by zero, the answer is infinity, a situation so removed from reality that the mathematical world may never come to grips with it, a number that does not easily assume bread and butter reality as other numbers do. And if you raise any number to the power of zero, the answer will always be one. Never more, never less. In mathematical terms, those three calculations look like – Nx0=0 N/0 = ??? N0 = 1 - 40 -
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CM: In gambling terms? RJ: Some gambling situations resemble multiplication by zero, because they contain an overlooked factor (the zero) that is equivalent to an overlooked gambling factor. A good example would be the trainer who is suddenly stricken by animal lover’s remorse and instructs his jockey not to punish the horse. The horse’s chances collapse to zero regardless of form. Other situations are similar to division by zero. You’ve won, but you can’t collect the winnings and don’t even know what they are. For instance, you take a pot of £100,000 and find that the player who called you has nothing more than £21.95 and the details of his business liquidation in his pocket. Finally, there is the index situation, the number raised to the power of zero, of which the equivalent is the odds-on shot that can’t gain you anything because the course levy wipes it out. CM: They all seem obvious. RJ: Believe me, this part of both gambling and investment can be the least obvious of all. Often because it has been deliberately inserted. (I feel an affinity with good old zero, wreaking the sort of havoc with mathematics, gambling and investment as I do in card games.) Let’s look at the main situations that are equivalent to the zero situation, and try to steer you away from them. - 41 -
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Rule 9: Never Bet Too Big... Red Joker: A big bet wipes you out if it goes wrong. Bets go wrong at times no matter how certain the outcome appears to be. A ranch in Arizona came to be called the Four Fives ranch because the owner financed its purchase by drawing out his fourth five against Amarillo Slim’s house of aces. His chances of doing so were less than 3%. Common Man: And a horse called Foinavon, whose own trainer tipped to win if every other horse in the race fell, won the Grand National when every horse fell. The chances were less than 0.2%. RJ: The trouble for a gambler who loses a big bet is that it drastically reduces his stake. It takes him a long time to build it up again. And when the bet comes up – it still causes problems. His zest for smaller bets is gone. They’re suddenly boring. He is tempted to another big bet on lesser evidence than before. Many professionals draft a rule for themselves that they will never risk more than 10% of their stake on an individual event. And most keep it even lower, 5% or less, until something marvellous comes along. CM: We can see where this is going, but it wouldn’t seem to apply very strongly anywhere except in property investment.
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RJ: Most investors who are betting too big are doing so without realising it. You are betting too big if most of your portfolio is in one area. It shouldn’t all be in pharmaceuticals. It shouldn’t all be in Europe. It shouldn’t all be in financials, or all in oil companies, or all in food produce companies. Financial vehicles that spread the risk across a number of areas avoid big-bet syndrome. Index trackers and exchangetraded funds are prime examples. CM: So a big bet that is actually a conglomeration of many small, sound bets is okay? Like a series of cross doubles on every race? RJ: Yes. And as well as spreading the risk across investments, it is vital to spread the risk across time. A series of varied investments made in an about-tostart-falling market can be just as lethal as one big investment. Most investments work out eventually, but it takes years, even decades. You must never have all your stake riding on a single horse. Betting too big is the equivalent of multiplying by zero.
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Rule 10: …And Never Bet Too Small Red Joker: Imagine a horse pundit so skilled that he can turn an average profit of 10% on every bet he makes. Imagine him going to the races on a daily basis. Imagine him puffing out his French-silk shirted chest, approaching the rails, flicking down a bundle of notes and drawling the number of his horse of choice. Imagine that each bundle contains five £10 notes and that he stakes the same on all seven races. How much is he going to profit? Common Man: Goodness, if he can pick them that well, a lot. Enough to keep him in French silk shirts, I reckon. RJ: Nothing, he profits nothing. His average profit on each race is 10% of £50, just £5. Multiply that by seven races – £35. Subtract the cost of admission, transport, and food, and he’ll be lucky to hold on to half of it. Say £20. Multiply that by 364 – he’s healthconscious enough to take Christmas Day off and Boxing Day in leap years – and you’ll get less than £8,000. CM [astonished]: This expert is doing less well than if he was on the dole. RJ: Very small investments cannot bring results. Rather, you should put your stake money into a deposit account and invest once or twice a year, or find a dripdrip form of investment that doesn’t charge for the
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privilege. No matter how small the commission, it mounts up. Betting too small is the equivalent of raising a number to the power of zero.
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Rule 11: Turn Down Proposition Bets Red Joker: Someday, somebody is going to show you a deck of cards and offer to bet you that the jack of diamonds is going to spring out of it and squirt cider in your ear, and you must not take this bet, because you are going to end up with an ear full of cider. Common Man: You are clearly quoting. Quite a good American Depression-era accent, too. RJ: Damon Runyon. The Proposition Bet had its heyday in the 1920s and the 1930s, when money lost touch with reality and newly rich gangsters sought endless ways of getting rid of it. The gambler would be asked to bet that the propositioner could not do something that seemed impossible, like driving a golf ball a distance of 600 yards. (Amarillo Slim Preston allegedly caught the same high-stakes gambler with this proposition twice, first by driving the ball over a cliff, then by driving it across a frozen lake.) The Proposition Bet has consistent features. The propositioner will come to the gambler. He will seem most keen that a huge amount should be staked on some unusual event that seems like a sure-fire winner. He may attempt, and fail, at small stakes, to demonstrate his own utter gullibility and incompetence. He will probably feign friendship and disguise the proposition as the sort of thing that he
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does against his own better judgement. He will repeat hurry, Hurry, HURRY. Invariably, the bet is won by carrying out the test in some strange, unexpected location or circumstances that just suits the propositioner. CM [confidently]: We’ll know the propositioner a mile off. He’s got sideburns the size of ploughshares and his jacket is brighter than Brandon Lee’s dressing gown. He’ll sidle up when no one’s near and go ‘Psssstttt!!!!!! I’ve got the best oil well investment ever, they struck last night and no-one knows but us...’ all the while glancing towards the street corner and listening for the plod of Interpol feet... RJ: If only, if only. It is the very reverse of being that obvious. It is often true that he will come to you (in the mail or by phone)... that his pitch will be energetic... that the offer will be in some way exclusive... and that there will be some unusual feature, like Nazi gold hidden in a hencoop, or Patagonian oysters that secrete diamonds instead of pearls... or, of course, an oil well about to gush or a secret merger between your brother-in-law and the Pacific Rim states. And there will be profit, profit, profit, for you beyond your wildest dreams. You will not often fall for the Proposition Bet if you apply all your usual rigorous checks. And accept that
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any investment that promises great returns, without spelling out how they will be realised, has to be iffy. CM: Of course, when the proposition comes from Wall Street... RJ: Yes. Taking a Proposition Bet is the investment equivalent of multiplying by zero. And it is a great deal more common in the investment world than it is in the gambling world.
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Rule 12: Visit the Parade Ring Red Joker: After the professional horse gambler makes his selection, weighing up the form, the going, the stable, the jockey, the horse’s racing style, the opposition and the trainer’s father’s stepsister’s maiden name, he may do one more thing. He may go to see the horses on parade. Common Man: And, if his selection is frothing at the mouth, rather than along the reins, or is limping, or looking at him with a funny glint in its eye, he folds up his figures, his form cards, his programme and his cash. RJ: And goes home. CM: But investment doesn’t have a parade ring. We haven’t seen many stockbrokers in funny hats dancing around the Notting Hill carnival. RJ: Visiting the parade ring is more important in the investment world than it is in the racing world. Investment parades pass you all the time. In the case of property, it is axiomatic that you should see what you are considering investing in, many times, before committing. That three-up two-down in Gondwanaland that looks just fine in the brochures is on the slope of an active volcano, is infested by termites, belongs to someone else anyhow and isn’t even built yet.
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For more general investment, watch what your hand is doing when shopping. Is it consistently singling out Mad Mouser Max Cat Food over Hilariously Happy Cat Food? If it is, what are you doing investing in Hilariously? Is it tooting the horn of a Merc? Buy Merc. You love stuffed mussels, but everyone you know gives you stuffed cockles. Invest in cockles. If your loved ones never come home without a couple of packets of Tweetie Neetie Sweeties, you ought to be the one selling to them. CM: We’ve been living in an investment parade ring since we were born! RJ: Investment parades, all the time. Watch the parade. If it works in the practice of the marketplace, the odds are that it works in the theory of the markets. Failing to watch the parade ring in racing isn’t a big deal, but failing to watch it in the investment world is the equivalent of picking your investments at random.
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Rule 13: Don’t Get in Hock to the Bookies Red Joker: This rule comes direct from J.P. “The Sundance Kid” McManus, the Irish bookmaker we have already discussed. He regularly jumped down from his stand to wager six-figure sums against his fellow bookmakers. Common Man: “The Kid’s Having a Go” was once a dreaded news item at Cheltenham or Aintree. RJ: McManus, by his own admission, borrowed money to finance his gambling/bookmaking enterprises at the beginning. From his father. When that went bust, he borrowed from his mother. He did not go in hock, or debt, to the bookies because he understood that, if he did, they would call the shots. While it is generally true that professional gamblers borrow to get back into the game after a losing streak, they do so in a limited way and for amounts that they can pay off by other means if required. CM: Not quite so easy in the real world. Everyone borrows. RJ: Yes. In the investment world every institution is a bookmaker of sorts. The Kid’s advice translates as: do not leverage yourself in so deeply that you can never get out. It is particularly apt in the area of property, because that particular form of investment involves debt, and lots of it. Expand with caution. Put
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on the brakes when tempted to leverage so hard that a short period of unexpected overheads and poor rent returns could put you in the hands of the receivers. And there is something even more important. CM: That being? RJ: It is even more important not to get into chronic, uncontrollable debt in your private life. The mounting credit card and overdraft interest will wipe out whatever your clever-clever investments might make, and then some. Chop the cards up when they feel hot to the touch. Clear your debts, all of them except the mortgage on your home, before you invest. Do not get into chronic debt. Getting into chronic debt is the investment equivalent of raising your resources to the power of zero.
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Rule 14: Keep Emotion Out of it Red Joker: All gamblers agree on one thing. Common Man: Going by the title, you are about to tell us that the moment you let emotion enter the picture, you are certain to lose. RJ: Two great big emotions, Greed and Fear, will lose both in the short and long term. Once Greed, or Fear, takes hold, objective judgement is gone. Betting when your fingers are practically touching the pot of gold through the rainbow, or when you are wondering what sofa you are going to sleep on tonight, is emotional betting that will go wrong. CM: And minor emotions also throw you off. There are professional poker players who cultivate insulting mannerisms purely because of the irritation and resentment they stir in other players, to get them to play emotionally. There are good players who lose their edge because they have just won or lost heavily, because they have been dealt hours of boring hands, because a member of the opposite sex has beaten them on a bluff, because the player opposite is of a different race, creed, or class, or because they haven’t eaten since breakfast. RJ [nodding]: All gamblers, too, agree on the cure.
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CM: Get out of the game. Watch TV. Take a yoga class. Walk the shoreline. Seek out a gardener or a farmer and talk to him about watching the grass grow. Come back when your head has levelled and the big veins in your neck have stopped jumping. RJ: There is absolutely no difference between the effects of emotional imbalance on gambling and on investing. If you’re emotionally involved, STOP. Walk away for a while. Those coffee futures aren’t going to smell as freshly ground when you get back. That collapsing supermarket chain isn’t, after all, going to collapse on top of you. And mother-in-law is still a pain in the neck, but not such a pain in the neck that you’re going to blow £20,000 just to wipe the smile off her face. And don’t forget that every penny spent is an investment. As the saying goes, don’t shop when you’re hungry. Get the best value. CM: Got it. Letting emotions get the better of you during an investment situation is the equivalent of dividing by zero. Anything can happen.
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Rule 15: Never Listen to Tips Red Joker: Geese that lay golden eggs, said professional racing gambler Alec Bird (or was it Phil Bull?) are not for sale. Possibly because those two great British racing gamblers had collared most of them. The great tipdisparager, Bird, drove a Rolls Royce, lived in a mansion, and drank nothing but champagne. Common Man: He never acted on tips – hence the golden eggs quip? RJ: Tips are endemic around racing. Suddenly the dogs in the street are barking that Can’t Lose ‘can’t lose’. You meet three people in the course of ten minutes who lower their voices, look furtively round, and whisper that Can’t Lose ‘can’t lose’. And you hurry to the rails. Without wondering... CM: …why should this information be out there? Why should John Citizen know it when Teddy Turf Accountant doesn’t? Has the horse told the jockey his intentions? Who undertook the mammoth task of making sure that every one of the 20,000 attendees at Royal Ascot should receive this investment advice? RJ: Precisely. Most tips are wrong. And even when they seem reliable, tips should never be acted upon. For two reasons. The first reason, that you will inevitably
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bet more than usual, and slip into the habit of betting beyond your means, you already know. The second reason is that the very fact that “everyone knows” will drive down the odds and make the bet unprofitable even when it wins. Tipsters are not to be confused, however, with advisers. A guy who approaches you with a whispered name, especially if is accompanied by a request for a loan when it wins, is a tipster. An adviser has studied the form and gives you clear, understandable reasons for his selections. CM: Phil Bull, for example. RJ: I am now going to tell you a little story, related to me by an old friend. ‘Take out your savings,’ said the voice on the six a.m. call. ‘Mortgage your house. Borrow on every pretext you can. Buy as many shares in Gusher Oil as you can get. They’ve hit big off the coast and the price is going to go ballistic before the week’s over.’ It did. Ballistic down, dropping by half. Still hasn’t recovered. The friend who got the call dilly-dallied so long – he was a non-investor and didn’t even know how to mortgage his house – that reality bit before he could invest a penny. CM: Thank goodness I didn’t get that call.
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RJ: Oh, you will. If the racecourse is a hotbed of tipsters, the investment world is a raging Vesuvius of them on a bed of nails in a lightning storm. It is seething, sputtering, flaming with bad advice. There is always a hot stock or always a far-off country whose property values are CERTAIN to double in six months. Along with the Next Big Thing, there is also the Next Bad Thing. Sell your shares in Chattanooga Caroline’s Cough Drops. There’s a secret report that they’re so carcinogenic and radioactive that only two in ten million people live to finish the packet. It’s out next week. Sell NOW. The investment tip – better known by its public name, rumour – is to be avoided for the same reason as the racing tip. The very fact that it’s being talked up/down makes the price either way too low or high, and you risk forming the habit of investing all the time. CM: It’s probably not true, either. RJ: Acting on a tip is the investing equivalent of raising your resources to the power of zero.
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Rule 16: Watch the Dealer Red Joker: The dealer can do many things in a friendly game of cards. He can mark the high cards with his thumbnail... Common Man: …he can deal across a reflective object, like a cigarette lighter, to observe your cards. He can deal from the bottom. He can slip in a pre-stacked deck. He can deal the second card down by an inconspicuous movement of his thumb. He can pick up the residue of the deck and play it as his hand if his dealt hand is rotten. He can signal a confederate what’s coming next. RJ: He can cheat. Professional poker players can spot a cheating dealer. Amateurs can’t. If there is one thing the serious poker player needs to do, it is to learn every conceivable way that the dealer can cheat, and learn what to look for to spot those ways. A serious player will never take his eyes, and ears, off the dealer’s hands. CM: You’re telling us that the investment world contains people analogous to crooked card dealers? RJ: This one transfers to the investment world in so unchanged a form that the dealer is often still called a dealer. The broker, dealer, auctioneer or agent who converts your investments from wish to reality occupies the same chair as the card dealer. With a few
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very subtle moves, or even one move, he can convert any chance of profit for you into a loss. CM: He can rig the deck? RJ: He can recommend an investment that is not suitable for you, but that pays him a large commission. He can load his services with hidden charges. He can invest recklessly in the hope of making a fortune on your money. He can generate unnecessary movement on your investment to collect more commissions and charges. He can flat-out steal from you. He can impose conditions that make it impossible for you to gain anything when inflation is considered. He can spin castles in the air on foundations of forecasts and estimates that turn out to be bricks without straw. He is almost unavoidable. CM: Maybe I should stick with gambling? RJ: There are two gambling-inspired ways of neutralising the investment analogue of the dodgy card dealer. One is to deal everything yourself. Buy your stocks online and find your property on foot and on camel. Create your own self-selected pension plan. Take control. Use the dealer/broker/packager/manager as remotely as if he was a card manufacturer or a racecourse car park attendant. The other way is to insist on a transparency so total that only one in a thousand deals measure up to your - 59 -
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standards. Find out everything before you invest, and if there’s something they don’t want to tell you, there’s a reason. Find it. If the dealer doesn’t want you to see his hands, he’s probably a crook. Not invariably, but often enough for you to avoid him. Trusting the dealer without establishing precisely what he’s doing is the equivalent of multiplying by zero.
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Rule 17: Don’t Bluff to Bluff Red Joker: The concept of the bluff, betting more than you’re holding is worth in order to scare off opposition, applies only to one area of gambling, poker. Common Man: Successful players rarely use it. With two exceptions. Good players know that they must run an advertising bluff from time to time. An advertising bluff is meant to let other players know that you do bluff. Otherwise, you will fail to make money on your good hands. Because everyone knows that you only bet when you’ve got the winners, they fold their hands. Texas Hold ’Em players, the second and most important exception, also make prolific use of the semi-bluff. That is a bet on an inferior hand that may well turn out to be the winning hand when all cards are dealt. It is not a bluff as such, more an elbowing out of other players who cannot or feel they cannot afford the risk. RJ: In the field of investment, you will only be in a position to bluff when you are in the middle of a faceto-face property deal or borrowing situation. It is axiomatic that you offer less money than you are willing to pay. You might also say that you are going to go no higher than a certain figure when, in fact, you are. The lesson from poker is that you shouldn’t really bluff at all. Once you set the final price in your head,
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mean it. Walk away from the deal rather than exceed that final price. CM: Don’t be bluffed. RJ: In every other form of investment, you will be unable to bluff – but you will be bluffed all the time. You will endlessly be bluffed that the offer closes next week. You will be bluffed that the market is set to collapse/rise/shrink to the use of one-eyed men over the age of 80 dressed in gabardine tweeds, close down completely, go beyond your reach forever, run out of quality products, or be kidnapped by Martians. The owner always bluffs that he wants twice the value for quick sale or is emigrating next week. The house on sale is the last one, there will be nothing but surplus Bedouin Army tents on the market until 2053. The lesson from poker is simple. Put in your chips if the hand merits it and hold on to them if it doesn’t. There is always another hand, and another investment, coming along in a minute. Letting yourself be bluffed is the investment equivalent of raising a number to the power of zero.
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Rule 18: Do Not Cheat Common Man: What, never? Surely opportunities for investors to cheat come along so rarely that we’d be missing our chance of a Guinness Book of Records entry if we passed one up. Red Joker: Gambling cheats do badly in the long term. They get ostracised, or shot, or are victimised by bigger cheats. Or they just become worn out by the tension of the whole business of living a lie. No one has ever made a poker fortune by dealing from the bottom. CM: We still fancy our chances in the Guinness Book of Records. RJ: An investor cheats, in my book, when he invests his money in an area of business that he would not enter in everyday life. An area that he feels to be wrong. CM: We are talking about ethical investments. RJ: Correct. CM: But a lot of them are too goody-goody. We don’t mind… RJ: …investing in Sugar Daddy’s Sugary Sugar Sticks, because we eat them ourselves and don’t care if other people think they’re bad for the teeth and fattening. That is my point. You will do well if you invest in some frowned-upon area of investment, but only if you do not personally frown upon it and would be - 63 -
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perfectly willing to go to work in it. But if you really believe that Sugar Daddy’s Sugary Sugar Sticks are ruining the youth of the country and wouldn’t go out selling them on any account, you have no business investing in the company. Subconscious guilt will get to you and you will, subconsciously, find a way to lose on it. Your investment vehicles should conform to your personal ethics. CM: I don’t see many haloes floating over your head. RJ: You will not see me investing in Sugar Daddy’s stuff, either.
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Rule 19: Engage Mathematics as Your Servant, Not Your Master Red Joker: What do you do in a pot-limit game of draw poker when all players but the opener have thrown in their hands, and you hold four of a flush? Common Man: Throw them in, of course. The odds against making the flush are more than 4/1 and the pot is offering odds of no more than 2/1. RJ: What do you do if you have been playing against this particular opener for years, and know that he will almost certainly call your final bet if you make the flush, knowing that the odds against you having improved are more than 4/1? CM: Play them, of course, in the knowledge that the odds offered by this particular pot have now improved to almost 5/1. RJ: Exactly. The opener has engaged mathematics as his master. You have engaged mathematics as your servant. You will not succeed in gambling without an understanding of the underlying mathematical foundations, but equally you will not succeed if you follow a mathematical system to the exclusion of all else. CM: This is rich, coming from you. You have been spouting mathematics since the moment we sat down.
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RJ: I take back nothing. What I say stands. I am merely adding a note of caution. The gambling world is full of people who follow systems that appear to be mathematically sound, but do not work in practice for several reasons. CM: Such as? RJ: Systems based on statistical evidence and the laws of probability. You could comb through the statistics for the last 90 meetings at Ascot, for instance, and come up with a system based on favourites in stakes races, and you would probably win – provided you had the common sense not to bet when it was snowing. Similarly, you can set up complex systems for investing on perceived natural cycles in stock markets. They may or may not work. However, systems based on statistics and probability are not the worst. CM: So what are the more dangerous traps? RJ: Let us go back to the card table. In the example I have given, your opponent failed to factor in the effect that his mechanically-applied methods had on the game, and on you. In the world of investment, when a large group of investors become aware of a promising model and began to use it en masse – selling at a preselected price, for instance – their very presence in the market distorts it and makes the model invalid.
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That is my first concern about purely mathematical models. Their very presence distorts the results to the point where they are no longer valid. CM: You have other concerns? RJ: Back to the card table again. A full house was an almost unbeatable hand when everyone played draw poker, a poor hand when wild cards were introduced, and is now a dangerous hand in Texas Hold ’Em because the open pair may give your opponent an even stronger full house. Situations change and models become redundant. CM: Does this mean that I can forget all the beautiful models that have been plucked from ever-advancing game theory, and applied to the markets? Seems such a waste. RJ: Not so. Back, for a final time, to the card table. You will do very well to familiarise yourself with as much game theory as you can stand. But you must constantly re-evaluate them in the light of changing circumstances. And, of course, never use a system you can’t understand.
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Case Study: The Craps Gambler Red Joker: The great all-American casino game is craps. Noisy. Fast. Emotional and compelling. The game of craps offers every conceivable bet that could be made on a pair of spinning dice – all at the same time. The score is calculated by adding the number of spots on the upturned faces of a pair of dice. It varies from 2 to 12. The dice pass around the table from shooter to shooter. All at the table can bet with or against the shooter as they please. If he rolls a total of 2, 3, or 12, he loses, and if he rolls 7 or 11, he wins. If he rolls 4, 5, 6, 8, 9, or 10, he must roll again and again until he either wins by making his point – rolling his original number – or loses, by rolling 7. That can take quite a while, and in the meantime, all sorts of side bets are made. If the shooter, or any player, backs himself to make his point, he receives odds so mathematically correct that the casino makes no profit whatever. Provided he wagers like this consistently, and wagers on nothing else, the house percentage against him drops to less than 1%. If he takes any of the flashier bets, he loses heavily. The Field Bet, betting on 2, 3, 4, 9, 10, 11 or 12 to come up at apparently generous odds, loses over 5%, and big six, big eight, hard way, and any craps exert an advantage of almost 17% against him.
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Common Man: The successful craps gambler, then, must keep his head when all about him are losing theirs. RJ: Provided he stays with pass and odds bets, as they are called, he loses slowly and gains considerably when the dice are “hot.” But when the excitement mounts and he starts shovelling money on big six, he loses fast. CM: It’s all about coolness under pressure, then. RJ: The successful craps gambler is the role model to follow when the markets are going crazy. Do not join in the melee and start hurling money at bets/investments you wouldn’t normally touch. It is important not to do things like releasing equity, cashing in life assurance, getting out of gilts for junk, and believing everything you hear. If you’re hoping to gain, rather than investing to gain, it’s time to stop. Markets, like dice, can run hot and cold. When the odds are genuinely attractive, the craps player is fearless. If your considered opinion is that an asset of any kind is being sold below its true value, it is time to buy, and buy hard. If your considered opinion is that luck is needed for an investment to come good, it is time to pass it by. The successful craps player never raises his resources to the power of zero.
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Case Study: The One-Armed Bandit Gambler Common Man [wrapping both arms across the top of his head]: The epitome of everything a gambler shouldn’t be is the one-armed bandit addict. Hour after hour, he stands there, slamming his coins into a bleeping, flashing Planet Zzogg 231495, until they are all gone. He’s in a trance. He forgets about hunger, thirst, girls, exercise, daylight, and moonlight, and Zzogglight. Red Joker: He is single-handedly responsible for the psychiatric school of thought that all gamblers ultimately gamble in order to lose. CM: Where to start? He is gambling against odds so unfavourable that he loses at least 20% on every coup. He is manifestly failing to manage his money. He is chronically chasing his losses and throwing away his winnings. RJ: He is in a permanent state of what American gamblers called TILT. TILT is an altered mental state during which all analytic ability goes out the window. It is not just a matter of poorer judgement. It is the transformation of an otherwise intelligent person into a full-on sucker who loses all sense of reality. It is the tilting of the most sophisticated device nature ever produced, the human brain, into a malfunctioning manual till.
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CM [ruefully]: Anyone can go into TILT. We know. RJ: Especially investors. Ask any investment bank. They’ll try not to tell you horror stories of how their best man suddenly lost it and started kicking billions all over the place. You will go into TILT one-armed bandit mode if you have too much action, for too long a period, without breathing spaces here and there. You will go into the Bandit Gambler’s altered mental state without noticing. CM: Get right away from it from time to time? RJ: Take breaks. Never lose sight of what is really happening. An investment in, say, a company specialising in systems for converting petrol-powered private cars to hydrogen-powered is just that. It will make just as much money as those guys in overalls lying on their backs can make. It isn’t a spiritual entity with unlimited growth. It’s guys with spanners, and what they can do under the bonnet. It’s what the car owner’s willing to pay. It’s an investment, nothing more. One-Armed Bandit Gambler investing is the equivalent of multiplying by zero while under the illusion you’re dividing by zero, and lucky to get out with the sort of return that would have been gained by raising all to the power of zero.
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Concept: Making the Theory of Large Numbers Work for You Red Joker: Gamblers do not generally refer to the Plateau concept by name. That is because they feel it is a simple concept that can be lumped in under such terms as “money management, percentages, and strategic play.” Or because they have never heard it called by that name. To a mathematician, however, it lies as firmly at the heart of all gambling situations as Parlays, Pitfalls, and Percentages do, and the mathematical analysis that flows from it can be taken to a very fine degree. We will take the analysis no further than required by gamblers and investors who wish to make money. Common Man: That’s me. RJ: I borrow the term from the late Nick the Greek, Nicholas Dandolos, who claimed to have won and lost more than seventy fortunes of a million or more dollars each in his lifetime. While casino gambling, he would set himself a series of targets. He would begin with a couple of bold bets and then increase them, if winning, or reduce them if losing. If he managed to grow his usual starting stake of $100 to a figure based on how lucky he felt – say, $250 – he would set aside his original stake of $100 plus some profit, say $80, and then gamble in the same way with the remaining $70 as if the set-aside
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$180 did not exist. If he managed to run the remaining $70 up to, this time, a more ambitious figure like $300, he would set another $200 aside and continue gambling with the remaining $100, which he would... CM: …either run up to another plateau, or go broke on, in which case he went home with the various set-asides, the plateaus, in his wallet. RJ: His pockets, actually, as he was notoriously careless with his cash... but, exactly. Once he had designated a part of his winnings as a plateau, the casino could not win it back. They could also not prevent him from running his winnings up to even higher plateaus. The mathematical theory on which casinos base their existence, the Theory of Large Numbers, could not work in their favour. CM: Is the Theory of Large Numbers a general justification of what we are trying to do here, or has it a more specialised mathematical meaning? RJ: The Theory of Large Numbers contends that the larger the number of chance events that take place, the more likely it becomes that the overall results of those chance events will tally with the statistical results predicted by probability theorems for those events. In layman’s language, the more events there are, the more likely it gets that the average result will emerge.
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In Nick’s case, the Theory of Large Numbers predicted that he would, in the long term, lose a rounded figure of 1.3% of the money he staked. He partly short-circuited it by varying his stake and quitting when he chose. CM: So we can do likewise? Can we do our bit of stock exchange short-circuiting? RJ: There are three ways by which you can make the Theory of Large Numbers work for you, regardless of whether you are gambling or investing. The first is to play casino. Identify a situation where the predicted result is in your favour and then stay with it over a very wide range of investments for a very long time. Unlike Nick the Greek, good horses or good shares cannot walk away. The racing form expert and the stock market expert must inevitably win long-term if they are good enough and have enough self-discipline. If they understand the concept of the plateau, they cannot lose. CM: And the other two situations? RJ: The corollary of the Theory of Large Numbers is that for small numbers, freak results are inevitable. A small sample of any series of events – half a dozen cards picked from a deck, a day’s horse racing, stock exchange movements over the course of an hour – can yield almost anything. You may end up with six red cards, seven winners, or a 5% plunge. - 77 -
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CM: So if we confine ourselves to just a few short-term events and plunge all we’ve got on them, we could get lucky and make a fortune. RJ: You have identified the second situation. It makes sense if you only go racing once a year or if you are building up investment experience, trying it first hand for small stakes. Otherwise it’s barking mad. CM: The third situation? RJ: It is not enough, this time, to state the general mathematical concept and wait for you to have that “A-ha! moment.” Failure to recognise that the third situation has arisen is behind the ruin of many investors. I intend to illustrate it by means of the binomial theorem. Take a race meeting where you plan to bet on four horses. We are going to talk about a four-race meeting where all four start at even money and your superior judgemental skills have judged those odds to be correct. For a single race, there are two possible results. Your horse can win or lose. Let us call those situations W and L.
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Over two races, there are four possible results, W-W, W-L, L-W, and L-L. Over three races, the possible results are W-W-W, WW-L, W-L-W, L-W-W, followed by W-L-L, L-W-L, and L-L-W and finally L-L-L. The number of results doubles every time, but your chances of winning out do not. Your chances of winning look like this – One race: 1 chance a winner, 1 chance a loser. Two races: 1 chance two winners, 2 chances one winner, 1 chance no winners. Three races: 1 chance all win, 3 chances two win, 3 chances one win, 1 chance none win. Four races: 1 all win, 4 three wins, 6 two wins, 4 one win, 1 none win. CM: It’s Pascal’s Triangle. The basic pattern of the Binomial Theorem– 1, 1 1, 2, 1 1, 3, 3, 1 1, 4, 6, 4, 1 RJ: Exactly, the basis of the rest of this lecture. (Those of you who dislike the binomial theorem may now skip forwards if you wish.) It comes into play when two - 79 -
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variables, x and y, are added and raised to the power of n. A sequence is yielded in which the value of any term can be predicted by the formula (x+y)n = nC0xn + nC1xn-1y + nC2xn-2y2 + nC3xn-3y3 For situations like the four horse race meeting, it supplies us with the relative chances of a particular result coming up. In this case it would be (x+y)4 = 4C0x4 + 4C1x(4-1)y1 + 4C2x(4-2)y2 +4C3x(4-3)y3 + 4C4y4 Substituting 0.5, the chance of winning, for x, and also 0.5, the chance of losing, for y, and 4 for n (the number of races) into the equation, we get the following; (0.5+0.5)4 = 4C0(0.5)4 + 4C1(0.5)3(0.5)1 + 4C2(0.5)2(0.5)2 + 4C3(0.5)1(0.5)3 + 4C4(0.5)4 which is 1(0.5)4 + 4 (0.5)3(0.5)1 + 6 (0.5)2(0.5)2 + 4(0.5)1(0.5)3 + 1(0.5) 4 You will see that it yields the Pascal’s Triangle pattern, and that we can work out the percentage chance of any of those events occurring by expressing 1, or 4, or 6, or 4, or 1 as fractions of 16. For four winners, it is 1/16, or about 6%.
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CM: I have been mentally projecting the Pascal’s Triangle progression as you speak, and I note that for large numbers of events, the percentages for numbers associated with break-even or near break-even results get larger as the numbers close to the centre of the progression become larger. RJ: That’s the Theory of Large Numbers in action. We’ve already clarified that. I will now explore the situations that arise when the number of events is small, as it is when your investment is in its early stages. Also what happens when your probability of winning – as it is in the investment world – is greater than 0.5. I will use the binomial theorem to predict the odds on a roulette-like game called La Boule, where the odds are heavily slanted against the gambler. The Boule wheel has four sets of numbers ranging from 1 to 9, but with the 5s replaced by a yellow spot. You can get evens on red or black, or 6/1 on yellow. Your chances of losing are 5 in 9 – just above 55%, or 0.55 – and your chances of winning are 4 in 9, just below 45% or 0.45. Assuming four consecutive bets, your chances of winning all four are 0.45 to the power of four, and your chances of winning three are 0.45 to the power of three, multiplied by 0.55, then multiplied by 4 because there are four situations in which that one number can lose. It’s the binomial theorem again, but this time x is the percentage chance of winning
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and y is the percentage chance of losing, expressed as decimals in each case. Try it coup by coup if you don’t believe me. You’ll find it works for any number of coups, but for convenience I’m confining it to four. CM: La Boule looks like a losing game. RJ: Confined to fairgrounds and seasides, offered by men who smell of... but I digress. Let’s look at what happens to your chances when you play. (0.45+0.55)4 = 4C0(0.45)4 + 4C1(0.45)3(0.55)1 + 4C2(0.45)2(0.55)2 + 4C3(0.45)1(0.55)3 + 4C4(0.55)4. You are welcome to dig out your calculator and to work this out. All right then, me. I can tell you that your chances of losing are of the order of 40%, your chances of breaking even are of the order of 35%, and your chances of winning are of the order of 25%. You will notice that this is a pretty bad deal, but you will also notice that your chances of coming out in one piece are a respectable 60%. CM: And the moral is? RJ: Twofold. There is a case for gambling speculatively, with small sums of money, on a very limited number of remote chances. I do not personally make that case, but it can work out well if you combine such a
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strategy with the Plateau concept, skimming off winnings when you happen to hit big. CM: Too much for me. We’re trying to leave gambling behind. Not interested. RJ: You would be, if you were the fairground La Boule operator, and you had an endless number of gamblers coming to you weekend after weekend. The operators’ mathematical position in the gambling world is similar to yours in the long term investment world. CM: You’ve already chastised me for harking back to what is obvious. What are the other implications? RJ: We are back to Nick the Greek. The much more important implication is that, in a gambling or investment career, the binomial theorem will inevitably cause you to go through what feels like winning and losing streaks inspired by angels and demons. They are not (unless I’m on the loose of course...). They are merely the short-term variations one would expect from the above. CM: We must not lose our cool. RJ: It is more than that. You must employ a strategy that will permit you to pile up your winnings during those illusory winning streaks, and limit your losses during the equally illusory losing streaks. Let me summarise. - 83 -
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The Theory of Large Numbers permeates every branch of mathematics. I have chosen to illustrate its effects by means of the binomial theorem. It is the underlying basis of the three situations that I lump together as the Plateau concept. First, when the odds favour you, as they do in longterm investment, the Theory of Large Numbers requires you to multiply the number of chancesituations, by selecting a wide range of investments, investing steadily in them over a period of time, and allowing them to run for as long a time as possible. Secondly, when the odds do not favour you, or are unknown because time is not on your side, a case can be made – just – for selecting a very small number of investments and cashing in quickly if they go well. Finally, and most importantly, you must limit your losses when the inevitable losing streaks associated with the Theory of Large Numbers come along, and accumulate your profits when the inevitable winning streaks come along. You must employ the Plateau principle. Now we will look at the relevant time-worn gambling principles, and see how to apply them, with the Plateau concept to the fore in our minds.
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Rule 20: Sessions Are Not Seasons Red Joker: We must distinguish, as gamblers do, between sessions and seasons. A session is a self-contained bout of gambling, a day at the races or a night at the tables. We will turn to the concept of the season in a few minutes. Common Man: I understand what a session is. It is meant to be fun. RJ: It is. The casual gambler who goes to the races or sits in a poker game is doing so for fun, and when he ends the day brick-red with fury and tearing his tickets or cards into a thousand pieces, that is all part of the fun. Winning or losing become irrelevancies. CM: Not much to do with investing, then. RJ: It has absolutely everything to do with investing. If there is one concept that gamblers are generally familiar with, and investors are not, it is that of the winning, or losing, session. Gamblers are not astonished by winning and losing. Investors are. Gamblers do not panic at a series of losses. Investors do. Gamblers do not stare in disbelief when an investment that would have financed a weekend in the Seychelles shrinks to the value of a burger and chips from a dirty white van in a lay-by. Gamblers learn to roll with the punches because they take so many of them. They also learn to manage their money in such a manner that no one session leaves them broke.
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CM: We have covered much of this already. RJ: We certainly have, and now we must discuss a few specific instances where investment is organised into sessions. You may be attracted by the idea of managing your own portfolio. You may decide, for example, to buy a basket of stocks every year – using some recognised tool, such as a low PE ratio – and selling them off a year later. That is a sound concept that fully employs my four winning concepts and is very widely used by successful investors. Or you may get really adventurous and try to trade in commodities and futures. When you do, you must think like a gambler. You must not panic and sell when the value drops slightly, and you must not feverishly sell when the value rises slightly. You must not risk all on a single session. And when the session is over, you must rise from the table, you must leave the track, calmly accepting that whatever has happened is all part of the overall season.
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Rule 21: Seasons Are Not Sessions Red Joker: An old poker aficionado told me once that he refused to risk more than 10% of his total stake in a single session, adding winnings and subtracting losses from the stake as he went along. Because he was not a particularly good or particularly bad player, his stake remained much the same throughout the year. But he did have good years, when he made a profit. And he did have bad years, when 10% of his stake shrank to such a tiny sum that he was obliged to stop playing for the rest of the year. Common Man: I admire his iron self-control. A year is a long time. RJ: In gambling, it is. Most gamblers would define a season as a matter of months, certainly not more than a year. Investment moves at a slower pace and we could define a session as a year or so and a season as a decade or more. CM: How do we manage a season? RJ: By monitoring your gains or losses. It doesn’t matter if you gain or lose sharply during a session. In a season, it does. If you are suffering steady losses, or merely breaking even, you need to find out why. It may be the market, it may be the times, or it may be you. You may be unsuited to that type of investment – I am speaking here of you managing your own
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portfolio – and should consider something a lot less hands-on. However, I am going to temper that advice with another that comes straight from the gambling tables…
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Rule 22: Don’t Think of Gains or Losses as Spending Money Until the Game is Over Red Joker: Old-timers advise novice players not to think of their stake as money, but as a means of keeping score. It can be added up when the game is over. Do you know why?” CM: Yes... and no. RJ: Cards, horses, dogs, and dice are all tools of the game, and all gamblers know that. What many of them do not know is that money is a tool as well. Halfway through a poker session, you may be seized by the notion that what you have lost, or won, at that point, would have financed a new suit and six French silk shirts. You have now lost sight of money as a tool of the game and thereby sentenced yourself to playing less skilfully and more emotionally. You will begin to lose. CM: And invested money is a tool as well? RJ: Precisely. It is important not to look at it in terms of purchasing power. Once you begin to see it in terms of new cars, suits, kitchen extensions and nights on the tiles, you are risking panic. Oh my goodness, that’s the price of a Jagu.... I’D BETTER CASH IN NOW, NOW!
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Crikey, I’ve lost more than I earned last month. GOT TO GET INTO SOMETHING THAT REALLY MAKES MONEY NOW, NOW!
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Rule 23: Manage Your Money Red Joker [grimly]: If there is one sentence that cries out to be shouted, it is the sentence I am about to utter now. Do not piddle away your chips. Common Man: That would have made a better title than ‘Manage Your Money’. RJ: Do not piddle away your chips. Do not piddle away your chips. Do not piddle away your chips. You must bear with me while I run through some examples from the race track and the poker table. There is a great deal to money management, a great deal. But 90% of it comes down to not piddling away your chips. Let us take our professional racing gamblers, Alec Bird, Phil Bull, J.P. McManus. Their strong point is, and was, the ability to recognise when a particular horse in a particular race is on offer at odds that are greater than its empirical chances of winning. There might be just one such horse at a particular meeting or even in a particular month. What do you think they did, or do, in the meantime? CM: Studied form, I suppose. And made other small bets, just for fun, and to pass the time? RJ: That is exactly what they did not do. Certainly they studied form. But they did not make small bets for
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fun. Those small bets would have steadily bled away their stakes and undermined the concept of the Plateau. There are poker players who stay for a round or two on every hand, reasoning that it only takes a few chips and they may get lucky. Those players are the most consistent losers in the game. When a Johnny Moss or an Amarillo Slim pushes his chips forward, he foresees a profit, either because he holds the best cards or is positioned to make a successful bluff. He is not hoping that the pair of twos in his hand will be joined by another pair of twos on the draw. He is not hoping that three large diamonds on the flop will join the two small diamonds in his hand. He is not telling himself that he will win because yesterday was Friday the 13th and his luck just has to balance out. He is not getting even with the bearded, monocled, foreignaccented guy across the table who bluffed him out of the last hand. He is playing poker, or, as in the racing example, betting to win. CM: You are looking at me very, very intently. RJ: In the great game of life, everything is in play. Everything. Your time, your money, your relationships, your social position, your education, your appearance, your health, your business, all are simultaneously a hand of life cards and a stack of life chips. You must not piddle away those chips.
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CM: If you will descend from your pulpit just for a moment, you might tell us what all this has to do with investment. RJ: That is what I am trying to do. I am saying that all of the above things are investments in your life, and the quality of that life will depend on how well you invest them. There is nothing in life so intangible that it cannot be assigned a life-chip value and later evaluated in terms of life-chip return. But, enough. You want to hear about money. CM: Yes. RJ: Let me simplify. You will not succeed at investment if you do not have money to invest, and you will not have money to invest if you... CM: …piddle away your chips; in this case, your money. RJ: I am not advocating that you become a miser. A true miser is a very poor investor by my gambling standards. If you manage to save an extra £50 per week by eating badly, and going about in rags, you have literally received a very poor return on your investment. I am not advocating that you give yourself a hard time in order to accumulate an investment stake. What I am advocating is that you regularly question whether your spending patterns bring you value for money in terms of quality of life.
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CM: An expensive meal for two on the last Friday of the month is a treat to savour? Expensive meals for two every night of the week turn into a routine that you barely notice? RJ: Yes. Similarly, the pleasure of driving a £70,000 car, when your means suggest that a £20,000 car would be appropriate, represents a net life-chip loss when the misery of being chronically in debt is factored in. And, of course, there are all those other things that bleed away earnings, magazines you barely glance through, cappuccinos you leave unfinished, unnecessary car journeys, clothes you wear once, overheated empty rooms, extended phone calls to people you meet all the time, repairable things discarded, impulse buys... CM: We must draw up a spending plan and stick to it. Otherwise we’ll never start saving. RJ: You must draw up a spending plan. It must be realistic and comprehensive. There must be a stake – in the gambling sense – for everything. Including fun. One of the biggest unrecognised chip-piddling gaffes around is the failure to budget for fun. CM: Go on. RJ: One of those stakes, of course, is your investment stake. If there isn’t one, you are automatically on a losing Plateau/Parlay series. You will sink into debt.
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I could go on and on and on about this widely unrecognised aspect of gambling and investment for ten times as long as I have. One more thing. Actually, three more things. Before you make a small purchase, take a deep breath and think again. Before you make a medium purchase, sleep on it. And before you make a big purchase, find a nice beach and lie on it. For a couple of weeks, at least. Until you are perfectly sure that you are not piddling away your chips.
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Rule 24: Set Targets Red Joker: Inherent in the concept of the Plateau is the concept of setting targets. If a racing gambler’s target is to double his money, he will stay with short-odds favourites, but if his target is to multiply it by a factor of ten, he will plunge on outsiders and accumulator bets. How you set your target determines how you bet. Let me refer you to Amarillo Slim on the first occasion of his winning the World Poker Series. He was down to his last $5,000 in a game where a realistic stake would be at least $20,000. Accordingly, he bet the entire $5,000 on the next hand he was dealt, reasoning that this apparently ridiculous play would draw in several other players – it did – and win him the appropriate stake, if he got lucky. He did. That is a rare situation, but a gambler is more likely to be successful if he knows from the outset how much money he wants to win. If nothing else, it will make him stop in time. You must set targets when you set out to invest. You want to retire at 40? Take a few calculated chances. You want to educate your first-born to your own level? You need an 18-year savings programme large enough to support a four-year college spending programme.
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You want to own your own home? Start your own business? Those are targets and they will help you to design your investment programme and to stick to it. And, of course, if you cannot stick to pursuing a target, you do not need me. You need a managed fund to siphon a regular sum from your earnings before you can get your twitching, greasy, broken-nailed hands out of your pockets in time to squander it. That’s all.
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Rule 25: Reduce Risks with Time Red Joker: I deduce, from the fact that you are still in this room, that you are a gambler who believes that you can make the transfer to the world of investment while bringing the discipline, concentration and money management principles required for successful gambling with you. And the coolness to ignore a minor insult. Common Man: Yes. RJ: We will now turn the Amarillo Slim anecdote in our previous piece on its head. Would Amarillo Slim have called the bet if he had been one of the other players, and had a large stake in front of him? CM: Probably not. At that stage of the game, his priority would have been to conserve his stake and his winnings. RJ: Exactly. The same applies to an investment of any kind when your target is in sight. If your investments have brought you within a whisker of that education programme, that early retirement, or that dream home, if there is only a year or two to run, this is not the time to invest in mulberry-coloured jade futures on the Pangaean Continent. That is the time to convert your investments to such non-scary vehicles as government bonds, broad-based tracker funds, cash on deposit, blue-chips that pay good dividends. - 98 -
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And even half-way through your programme, it makes sense to begin moving profits to those safer vehicles. You are, remember, setting up a series of Plateaus.
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Rule 26: Look for a Middle Red Joker: Mr Mario Puzo, author of The Godfather, had a friend who was a professional gambler. He was called Salvatore Ragusin, or Sally Rags for short. Mr Puzo was the first person I heard referring to the gambling concept of a Middle. Sally Rags bet extensively on the games of baseball and American football. Betting on those games often means taking odds that lie close to evens. A careless bookmaker could get his figures mixed up and offer a team at 6/5 when it should be 5/6. Sally Rags briefly located such a bookmaker. For a week, he and Mr Puzo were able to bet against their selected team at 6/5 with their usual bookmaker, and then with it, at odds of 6/5, with the erring bookmaker. Until the error was discovered, their daily investment of 10 units brought back a total of 11 units. That is a Middle. It is a situation where you cannot lose. Common Man: A rare find. RJ: Not when communications were poorer than they are today. A gambler who was willing to travel from London to Paris, for example, could get good London odds on a French-trained horse running in England and equally good Paris odds on the horse’s opponents. Each nation preferred to support its local sheriff. The late Irish gambler Terry Rogers was a regular user of this particular Middle for much of his life.
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The Middle, in investment terms, is almost invariably offered by government. There are a hundred different ways of structuring savings and investments so that the cost is partly borne by the government. The street name for such structures is tax relief. CM: I’d never have guessed. RJ: Like Mr Ragusin and Mr Puzo, you can go to bookmaker A, the taxman, and pay your taxes, then go to bookmaker B, the savings structure, and get the tax partly returned to you. When you consider that the savings involved can be 20% or more, you have a very large Middle going for you. CM: So we should study every government scheme and structure, no matter how tortuously worded, no matter how vile we consider the Chancellor’s taste in ties and haircuts, and find one that permits us to offset tax contributions against our savings? RJ: There are websites, books, and independent financial advisors who can and will do that for you. Bear in mind, however, that even tax incentives are not a good enough reason for signing up to schemes that violate the other principles I have outlined to you so far. Beware of annuity schemes that are disguised descending Plateaus. Beware of structures that fail to keep pace with inflation.
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Beware of wildly speculative schemes. But if the scheme is good enough, there is nothing better than the Middle offered by government. There is also a school of thought that public companies paying out little or no dividends are Middles in their own right, as profits are not eaten up by taxation. You will do well to keep that concept, also, in mind. CM: I’ll be bored stiff, but I’ll do it. Are there any other Middles around? RJ: Yes. Owning your own home. We will return to that shortly.
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Case Study: The Blackjack Gambler Red Joker: It pains me to say this, but the casino gambler from whom you can learn the most is the Blackjack Gambler. Common Man: What have you got against this harmless punter who merely wants the pips on his cards to add up to twenty-one? RJ: He plays with four decks and I am not in any of them. And what irks me most is that he is right. Blackjack is the only casino game where the odds favour the customer. By observing the cards dealt, the mathematically aware Blackjack Gambler can enjoy an edge of 3% or so. CM: Not an advisable thing to do. Especially in the days when some casinos operated their own private cemeteries. RJ: You are right, casinos do not accept blackjack players who have demonstrated sufficient intelligence to play the game properly. But even without card-counting, blackjack is a game where intelligent play cuts the house edge to almost zero. Provided the Blackjack Gambler learns seven or eight rules of thumb and applies them, his losses will be infinitesimal. CM: Okay, he’s already taught us to avoid shady deals and to learn the basics before we start. What else can he tell us? - 103 -
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RJ: To manage your money so that you are ready to take advantage of favourable circumstances. In blackjack, you are permitted to split your cards and to double your bets in certain cases. It can be good play to do so. Inevitably a period of the game comes along when you are justifiably betting more than usual. Exactly the same thing happens in investment and you learn, once again, to keep some savings in ready cash to ride out bad spells and take advantage of good spells. We are back to where we began, building up our Plateaus and protecting them. We must now turn to something else. CM: Is it what we think it is? RJ: Yes, my friend, we are, at long last, ready to discuss Percentages.
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Concept: Percentages, Odds, Ratios and Probabilities Common Man: I am surprised that you left the concept of percentages until last. Most gamblers and many investors talk about nothing else. Red Joker: My point exactly. Gamblers always think they understand percentages. In reality, many do not, or do not distinguish between several linked mathematical concepts that can all be loosely described as percentages. I will begin with the house percentage. As defined by casinos, bookmakers, and odds-layers in general. Let us say that your only gambling passion is for the red chances at roulette. You will double your money on 18 occasions, lose it on 18 occasions, and lose half your stake on the one remaining occasion when zero comes up. That is a return of 36.5 units from 37 situations, giving the house a profit of 0.5 units, which expressed as a percentage of 37 is less than 1.5%. That is the house percentage. It is also known as the house edge. CM: It seems to us that it is very little different from the percentage profit that would accrue in any normal business. RJ: It is not different at all. You will see that it is impossible to be a professional gambler specialising in casino games, as the house percentage is your
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percentage loss. But herein lies our first lesson on investment. In the gambling world, you can choose those casino games whose house percentage is low. By so doing you lose your money more slowly. The same roulette table, for example, offers novelty bets yielding a house percentage of more than 2.5%, and other games on offer can take as much as 16%. Transfer this concept to the investment world – where in the long haul you are the casino/racetrack that takes the house percentage – and it will become clear that percentage returns vary. Broad statistics show, for instance, that long-term investments in shares are likely to yield a higher percentage return than those in property, and that those in property yield a higher percentage than bonds. Gamblers call this concept the edge. Investors call it performance. CM: You said there were several concepts that gamblers lump together under the general term of percentages. RJ: Yes. Gamblers make frequent use of the term in connection with the terms probability and odds. Probability is the chance of winning versus losing expressed as a decimal rather than a percentage. A horse that a gambler deems to have a 25% chance of winning has a 0.25 probability of winning, and as
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probabilities are based on a unit of 1.0, then it also has a 0.75 chance of losing. The ratio of winning chances to losing chances is 0.25 to 0.75, and the ratio of losing chances to winning chances is 0.75:0.25. To brains as keen as yours, stuffed as they are with mathematical ability to the detriment of horse sense and savvy and common copon... CM: …that is a ratio of 3:1. Expressed as odds (a fancy name for ratios) it is 3/1. Those are the odds that the gambler must receive from his bookmaker in order to break even in the long term. RJ: He can break even by sitting at home and taking up one-handed macramé instead of horse racing. Can’t you see where this line of reasoning is going? CM: Sorry. RJ: What will happen if the gambler’s experience and analytical ability lead him to conclude that the percentage chance of his horse winning is 27%? CM: He will require odds of 73/27 to break even. RJ: Believe me, you will attend many a Glorious Goodwood before you see such odds offered. The bookmaker will probably cut the price to 5/2 to maintain his edge. But not always. If his judgement is inferior to yours, or that of the other gamblers
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placing their bets with him is inferior to yours, he will leave it at 3/1. CM: Our gambler will get back his 27 unit stake plus three times that, or 81, as well! RJ: Exactly. We are back to percentages. Over the long haul our gambler will receive back 108 units for every 100 units staked. He will enjoy an 8% edge, or percentage, for his careful studies. CM: So what gamblers really mean by percentage is the search for a gambling situation where the odds offered are a little bit better than empirically they should be? RJ: Yes, although that is not quite all. We have yet to consider the modus operandi of the professional card player. What will happen, for example, if a professional poker player is dealt two small pair in a game of draw poker? What will the draw player do – stay, raise, or throw in his cards? CM: He will probably stay if only one or two other players are active, raise if he is close to the dealer in order to drive out other players, or throw in his hand if there is strong betting. What have percentages got to do with all this? RJ: In the first and third cases, he is merely reading the percentages in the same manner as the horse player - 110 -
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reads his form figures. The percentage/ratio/odds situation is favourable for two small pair against one or two active players, and unfavourable against players who have been betting actively. It is the second case that is interesting, because by driving out other players he is transforming the situation that will develop after the draw. He is metamorphosing it from the third to the first case. CM: He is actively altering the percentages. RJ [clapping his hands]: Precisely. What gamblers really, really, really mean by the term percentage is the ability to control the percentage profit or loss by taking positive action. We will now study how to go about doing that.
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Rule 27: Study the Form Red Joker: To a non-gambler, or even to most gamblers, it seems incredible that Alec Bird, Barney Curley, Phil Bull, or the other greats among professional gamblers would devote three or more hours to studying a race, then decide not to bet on it. Incredible and pointless. Common Man: Not, apparently, as those men and many others lived in mansions and drove Rolls-Royces. What on earth were they studying during those hours? RJ: Form, as exemplified by each horse’s best times over the distance, running style, prize money won, most recent form, and a host of other factors that we need not go into during this discussion. I am not trying to educate you on how to pick winners. I am trying to make you see that you cannot possibly distinguish winners from losers unless you learn everything that there is possible to be learnt about them. I am trying to make you see that professional gamblers put a great deal of study into any gambling situation before they risk money. CM: Professional poker players, too, put a great deal of study into the laws of chance as applied to card situations, and into their opponents’ style of play. RJ: We will return to that. What we must now attempt to do is to transfer the concept of intensively studying form to the main investment situations. It is a
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horrifying fact that not only do most investors know little or nothing about their investments, they also often do not know what they have invested in. CM: Why should they? Do not the institutions offering us investment vehicles sort out all that for us in advance? RJ: Certainly, but if you intend placing your entire faith in managed funds, you are listening to the wrong person. Managed funds make you safe, not rich. I intend to demonstrate that their results are mathematically likely to be so-so and my recommendation is that you take an active part in selecting your own investments, be they in property, equities or bonds. And that you study the form. CM: How about a few examples? RJ: The late great Phil Bull was willing to spend three hours studying a race on which he might, or might not, bet £2,000. How long should you spend on studying a £200,000 house that you are contemplating buying to let? Should you drive around there at different times of the day and night to assess the neighbourhood? Should you acquire copies of bus and train timetables, matching them up with survey maps on which colleges, hospitals, and factories are marked? Should you study the Town Development Plan and its chances of being implemented? Should you find out who lives next door, what state of repair the house is in? Even if you spend every spare minute
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doing so for a month, you will not, in proportionate terms, have studied the form as intensively as Mr Bull studied his figures. CM: And, I suppose, you would have us study the financial reports of a publicly-traded company over a twentyyear period, you would have us find out its entire history and management structure, its five-year plan, and so on? Where will we find the time? RJ: There is never time to do anything properly, but there is always time to do it again when it goes wrong. The time you will spend finding out about an investment is trivial, compared to the time you will spend retrospectively finding out about it, and brooding over it, after it goes wrong. Besides, most prospects can be assessed in a couple of minutes. Only the specials require intensive study. You can improve your edge even without specialist knowledge just by discarding certain situations. CM: Give us another racing example. RJ: Certainly. A gambler who selects his horses at random loses some 14% of his money on every bet. If he eliminates handicap and maiden races, he can cut that to 10%. If he bets only on favourites, below 5%. If he stays with favourites whose starting price is just about evens, or slightly above, he can almost cut his losses to nothing. Knowing what not to do is as good as knowing exactly what to do.
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I intend to spend the next few moments explaining exactly how the principles of percentage-conscious gambling transfer to the investment world. I intend to fill your ears with sound advice.
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Rule 28: Turn Down Most Bets Red Joker: This is also known as Improve Your Edge. Common Man: I am a simple, uncomplicated person. I do not know if I have the intelligence and application to work out the exact percentage chance of an investment’s success. RJ: You will not need it. Apart from a few specialists, no professional gambler will waste time on a race, or on a hand of cards, where the chances of success are difficult to assess. Most professional punters will not even read the runners or riders in a handicap or maiden race. Most professional poker players will throw in a small pair regardless of the game or the state of the betting. Most bets, in short, represent poor value. It is part of the mindset of the successful gambler that he has the discipline to pass them up. CM: So we do not have to go through the entire FTSE or the entire property section? We can pick and choose a few likely situations and study them intensively? RJ: Yes. CM: But most investments work out okay. We surely don’t need to study them as if we were going to be appointed chairman of the board next week. You know the one about the monkey and the pin and the FTSE. RJ: The investment equivalent of the housewife and the pin and the Grand National. Of course they find
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winners – there are tens of thousands of pins and only forty horses – but they would find far more winners if they confined their pin-sticking to a shortlist of fancied horses. I am going to give you three observations on this aspect of things. Number one, just as there are good bets and better bets, there are good investments and better investments. To take a crude rule of thumb, you are more likely to find good investments among big, established companies. To take another rule of thumb, you are most likely to find a good investment among companies whose profits are consistent. Number two, if there is something iffy about an investment, you will notice it quickly. Just as a professional gambler would discount that race and go on to the next one, you, too, can discount that investment and go on to the next. There is no need to devote three hours to every race. Number three, it’s never the last chance. There is always another race coming along. When in doubt, stand back. You are looking for a prospect that is significantly better than other prospects. CM: And when should we be in doubt? RJ: You should always be in doubt. Or almost always. Because, in gambling and in investing, small percentages are big percentages…
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Rule 29: Small Percentages Are Big Percentages Red Joker: I am going to relate to you a story, first told to me by Jeremy Flint and Freddie North, authors of the most honestly titled book ever written about gambling, Why You Lose At Racing. The story is about a successful gambler who drove a 500 mile round trip to bet on a horse he had selected at a racecourse far distant from London. The horse won, and next day, Flint and North asked him how much he had won. ‘Not a penny,’ was the curt reply. ‘My price was 2/1 and the best I could get was 7/4. I didn’t bet.’ Common Man: All that driving for nothing! RJ: By the logic of the professional gambler, he did as he should. Assuming he was going for the generally acknowledged profit margin of 8%, he had assessed the horse’s true chances of winning at 36%, the required ratio required being 2:1, or 72:36, giving a mathematical return of 108 units to every 100 staked. The bookmakers’ offer of 7/4 would have brought a mathematical return of 99 units to every 100 units staked, an infinitesimal loss but a loss nonetheless. The difference of a quarter of a point, slightly more than 8% in terms of return, was enough to rule out the bet. But far less would have put our professional off. If he was offered the next highest price of 15/8, a
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difference of some 4%, he still would not have bet. The profit margin, although real, would have been too low. CM: He is one tough grader. RJ: I can go on to give you examples from the world of poker and tell you of players who will play a pair of kings to the hilt but throw in a pair of queens – but I would rather you stayed with the example I have given. A lessening of 4% in return would have been equally disastrous. His actual profit of 4 units as opposed to 8 units would have been 50% lower than the target he had set himself, a target quite deliberately chosen to leave a margin of profit after inflation, running costs, and what he had decided would be his annual income. CM: So, when we invest, we should draw a heavy line in red between estimated returns of say, 5% and 8%, even though they look almost the same? RJ: Small percentages are big percentages. Yes. You should draw an even heavier line between management charges of 1% and 3%. CM: Hold on, that really is tiny. RJ: A successful investor can expect his choices to stay ahead of inflation by between 5% and 8% per annum. Let us take the higher figure and assume management charges of 3% as opposed to 1%.
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How much lower will his return be at 3%? In cash terms? CM: He will make £50 per thousand invested as opposed to £70. He will lose 2/7 of his profit. So he will lose almost 30% of his profit. RJ: And in the following year? CM: I haven’t got a calculator handy, but he will lose another 30% plus the return he would have gained on the actual £20 lost. And it will get worse every year. He may not even beat inflation if things get rough. RJ: I rest my case. Small percentages are big percentages. You must always bring a percentage figure back to the real numbers involved to find what impact it really has.
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Rule 30: Study Your Opponents Red Joker: Even the greatest of poker players have a tell. A tell is an apparently trivial pattern of behaviour that alerts other players, if they are perceptive enough, to whether or not they are bluffing. Of course, those poker players who fall short of greatness have so many tells that the professional poker player can tell what they are holding entirely by their body language. I would recommend to you a book called The Education of a Poker Player, by Major Herbert Osborne Yardley. Much of what it has to say is dated but you will discover that Major Yardley, while still a teenager, got his start in poker by observing a tell. He observed that a skilled semiprofessional older player always switched his cards from one hand to the other before he bluffed. He used the fact to make a small fortune. Common Man: You are not going to tell us that stockbrokers switch their Blackberries from one hand to the other when they are selling short. This is useless advice. Why, we haven’t even got opponents. RJ: Yes, you have. Everyone out there is your opponent. Everyone out there is either trying to take your stake by selling you something above its value or charging commission on selling it. Your opponents are those people who form the market.
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CM: They’re not here, so how can we observe them? RJ: By observing what they do. Once you know what they are doing, you can either join them or resolve to beat them. CM: You mean that markets, of all kinds, become distorted because there are runs of buying and selling sparked by trivial events? Because it is in the interests of salespersons to misrepresent their product as being extra good, or about to run out? That we can become familiar with market trends and use them to our advantage? We can use our heads? RJ: Exactly. If shares, or property, have risen rapidly in value, either as single units or collectively, you must ask yourself whether the rise is justified by the facts. If it is, buy as soon as possible. Similarly, if a fall in value has no convincing cause, it is time to buy. It is not what your opponent is doing that matters. It is whether your observation of him bears out that his reactions are in line with reality, or not. CM: We must kibitz the game, as Major Yardley would say. RJ: You must. Especially when you are not actively investing, when other players are getting the cards. That is when you build up knowledge of how the game works.
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Rule 31: Beware of Long Odds Red Joker: If a horse is on offer at 33/1, it means one of three things. The animal would have trouble outrunning a fossilised tortoise, the animal can run like the wind but the trainer has reached a quirky personal decision to which only the jockey and his bookmaker are privy, or the animal is a running sensation that nobody has noticed. Common Man: The statistical odds on the last option being correct are about 130/1. We checked. RJ: Good. It is the same in the investment world. When you are offered what seems an incredibly high level of return, and offered it with blandishments and promises and bodily elevations from the seat, one of those three 33/1 situations has arisen. The first is that, like the animal that can’t run, the investment is a risky one. The salesman may mean the best, but he is not going to get his commission unless he sells to you, and he will talk the investment up and make it look attractive. You will encounter this situation frequently when you invest in mysterious properties and emerging markets from afar. The second is that the trainer’s intentions were not arrived at under the advice of his moral and religious counsellor, and that the mere £5,000 you must invest in order to gain £50,000 will be invested in a bar in Rio de Janeiro. One round at a time. The third, that
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the scheme is a winner, can occur in real life, and you may have the knowledge of the relevant field to discover that. But generally the promise of huge returns results in huge losses. I am not saying that you should totally confine your investing to large, publicly traded companies with low PE ratios, to tracker funds, or to properties that have shown a regular return for the past ten years. I am too much the Red Joker for that. But I would beware of long odds, at the racetrack and when investing. I would generally stick with the favourites.
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Rule 32: Never Follow a Springer to Starting Price Red Joker: A springer is a horse that starts out as an outsider and is bet down at the racecourse because the connections fancy its chances. Common Man: We know. It opens at 12/1, the connections begin betting, everyone catches on and it starts at 3/1. We’ve been there. RJ: So you know that, if you manage to get your bet on at 12/1 or close to it, you will profit in the long term, but if you bet at 3/1 or close to it, you will lose in the long term. CM: Yes, because the connections are not infallible, either. They only know the horse is in good shape. The true price is about 6/1, and it only falls below that because half the attendance is in there betting. The bookies must balance their books. RJ: The springer is not be confused with the tip or the rumour. The springer, in investment terms, is a prospect for which there is credible evidence that success lies in store. CM: But you must get in early. RJ: Exactly. If a new field of investment opens out, or a new market develops, you may well gain if you invest before it gains momentum. But once it is up and
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running, and the public see it as a golden opportunity, the price will become prohibitive. It is then a very bad idea to invest at all. Many, many recent events come to mind.
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Rule 33: Never Bet Ante-Post Common Man: I, myself, am adamant on this one. Betting on a horse months before the race takes place makes it impossible to calculate the percentage. There are too many unknowns. We are surprised that you even mention it, because investment by its nature is ante-post. Red Joker: It is. CM: So this rule does not transfer to the investment world at all? RJ: Only in two situations. CM: Which are? RJ: Some investment vehicles are so volatile in nature and so short-term in effect that they are full-blooded gambling. We have already referred to commodities, to spread betting, to flipping of properties. All those are essentially ante-post betting situations and you should only enter them if you have remarkable skills or very little time in which to work. CM: Tell us about the other situation. RJ: Buying your own home. I raise this point because buying your own home appears on the surface to be an ante-post bet. It will be decades before you know the true result and anything can happen in between. But it is not an ante-post bet, and when the conditions
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are suitable, it becomes that rarest of gambling situations, a middle. CM: How so? RJ: Because, assuming you will be granted a normal lifespan, and all investment assumes that, you will have to pay rent to keep a roof over your head in any case. That money is already lost. By buying your own home, you can recover it. You can also eliminate all payments after twenty years or so, creating a free winning bet. CM: But sometimes the house market is prohibitively expensive and we can barely afford our rent, let alone a much larger mortgage. RJ: In that case, it ceases to be a middle and becomes an ante-post bet. In general it becomes an ante-post bet if the price strays too far above the 3.5 ratio to your current income that mortgage lenders have offered since time immemorial.
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Rule 34: Get to Know the Trainer Red Joker: A proportion of small stables stay in business, or become bigger stables, by betting on their winning horses. They know when their mount is fighting fit and they know what to do to keep him that way. I would refer you to the early training career, for example, of Mr Ken “Duke” Payne, whose book The Coup is required reading. The trainer is the person to talk to if you want to find a winning bet. Common Man: Only if he’s an absolute imbecile. I’d say we’d be better off on friendly terms with a stable boy, the friendship being cemented by a share in the winnings. RJ: Trainers, too, have friends. But that is not the point I am making here. The point I am making is that your chances of selecting winners improve if you have a hand in creating the race, and that your chances of a successful investment improve if you can personally influence the outcome in some way. CM: Like using the money to open our own business? RJ: That is one way. I would only advocate it if you have long personal experience or considerable training in the business. Many trainers fail because they are not good enough, or get unlucky. Up to half of all businesses fail for the same reasons. If you have a dream of opening your own restaurant but have never successfully boiled an egg, you are in the position of
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a trainer who has yet to discover that horses haven’t got feet. That being said, there are people who will never rest until they open their own business. And it is only by running your own business that you can become truly rich. I am merely saying that if you choose that route, you must have all the skills and experience on your side. And a burning desire. CM: Perhaps I’ll struggle on backing the horses and trying to work out what the trainers are thinking. Like professional racing gamblers do.
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Case Study: The Professional Racing Gambler Red Joker: Our session is almost over. Before I depart – though I will never, as you have guessed, entirely depart from your investment and gambling lives – I will summarise what I have had to say. I will do so by drawing your attention to that most fully-rounded of all gamblers, the Professional Racing Gambler. You may make the case that the poker gambler is the truest and finest of all gamblers. You may be right. Nevertheless, I will use the racing gambler to summarise my final points, because he of all gamblers most resembles the investor you wish to become. 1.
He, first of all, must master the concept of percentages. He must learn to consider all the facts, assign them their respective values, and make his decisions. Investors must learn to do that.
2.
He must then learn to manage his risks. There are no certainties in racing. There are only, as in all walks of life, risks that are calculated, and acceptable risks, versus risks that are not.
3.
He must put his money to work, and he must discipline himself to keep it working. Money is never static. It is always either winning or losing itself and must be disciplined by good management.
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4.
He must, above all, know when to walk away. He must learn to search out...The Right Horse in the Right Race at the Right Price.
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Part 4: Percentages
Rule 35: The Ultimate Rule Find the Right Horse in the Right Race at the Right Price Common Man: That’s it? That’s the ultimate rule? I heard that old saw the first day I stepped onto a racecourse. Red Joker: Indeed you did. And no doubt felt a flash of irritation, because at the time it meant nothing to you. As you went on, you learnt how to put it into practice. As you will with investment. CM: The right horse is the horse with the most outstanding form. It is a relatively rare find. RJ: And the right horse/investment is the one which, after prolonged, intensive, dispassionate study, has all the hallmarks of a good investment. As we have been demonstrating. CM: The right race is the one which suits the horse in terms of distance, ground conditions, quality of opposition... RJ: …the right race/investment is the one that suits you personally in terms of your means, your existing portfolio, your temperament and the stage you have reached in your investment career. CM: The right price is the price that offers the greatest return in relation to the amount staked. RJ: The right price/investment is the one which, again after prolonged, intensive, dispassionate study, the
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Red Joker Rules
one which has all the hallmarks of being lower than it should be in relation to its likely performance. CM: So I am going out there to find good investments in suitable kinds of vehicle at prices that are lower than average? RJ: Yes, you are. Armed with the knowledge and experience that your years spent with me – though you were not keenly aware of me – have brought you. And now it is farewell.
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Epilogue ‘Farewell,’ the Red Joker said. He rose from the table. His ceaseless activity had rubbed the dust from the table and it glowed warm and bright between us. ‘Will we meet again?’ ‘Certainly. We will meet every day during your investment life as we did during your gambling life.’ ‘I do not mean that. I mean in person – the Common Man face to face with the Red Joker.’ ‘That is unlikely.’ The Red Joker smiled. ‘But then, I would not be the Red Joker if I did not sometimes do the unexpected.’
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Red
Joker
Rules
“Gambling is investing, and investing is gambling,” says the Red Joker. Both situations begin with a common pool of money. The pool is distributed among those who have created it on the basis of a series of events that are partly controllable. Through a mixture of skills, self-control and sheer luck, some of those who have created it will receive more than others. There is no inherent difference between sifting through a horse's prospects of winning a race and a company's prospects of returning regular profits. There is no inherent difference in deciding whether to raise the betting on a particular hand of cards and deciding whether a property is a good or bad buy. But there is a world of difference between the pace of gambling and the pace of investing. A gambler faces as many investment situations in a week as an investor does in a lifetime. The rules are the same, but the gambler is in a situation where he can learn the rules very quickly. This is a book of advice from the gambler to the investor – The Red Joker Rules.
Hh
ISBN 978-1906659172
Harriman House
£12.99 9 781906 659172
