Six Lessons for Investors from The Gambler

One of the most famous songs by or about cash is Kenny Rogers’ ‘The Gambler’.  While the origins of the song may have been meant for playing card games, such as poker, the lyrics contain insights that apply equally well to speculators of all types including investors and traders alike.

In this song, two travelling fellas find themselves sitting on a train together, staring awkwardly into the darkness outside and at each other.  The gambler, sensing an opportunity finally breaks the silence and proposes a trade: his advice for the last of the traveler’s whiskey.  While it’s tough to say who got the best of that trade, here are six important lessons for investors to ponder that came from that exchange.

Lesson 1: if you’re gonna play the game, ya gotta learn to play it right

While it seems self-evident to suggest that if one is to play a game they ought to do so correctly, the implicit reference is that there is, in fact, a ‘right’ and a ‘wrong’ way to play a speculators game.  One interpretation of the phrase is that there are those that gamble for the sake of gambling and those who gamble to win.  Games can be for fun or they can be played professionally and in terms of investing, the same could be said for those investors that do it for amusement and those who speculate in an informed manner with the objective of making a profit.  Money is usually made by one at the expense of the other.

Lesson 2: you gotta know when to hold’em, know when to fold’em

While this best known phrase references a card game, it most certainly applies to investing too.  The perennial challenge to investors is knowing exactly when to stay in a position or when to exit.   Whether it be through hard stops (e.g. making x% and then exiting), stop-losses, risk/reward based thresholds (e.g. making some multiplier of the amount risked) or some other method (e.g. guessing), the genius of the phrase is in its subtlety. How does one “know when to hold’em”?   Presumably this knowledge comes by having rules and experience with those rules, not only for entering but also for exiting.  Professional traders and novice traders may take the same risk on an investment, however professionals manage their risks much more carefully recognizing that if required, they will be ready to ‘fold’ – an expensive lesson many novice investors come to learn the hard way.

Lesson 3: know when to walk away and know when to run

This third lesson is a dramatic articulation of the fact that speculation can be a dangerous exercise.  While you’re not likely to encounter pistol-toting hustlers, your own bad decisions can be an equally threatening force when it comes to your longevity as a trader. Whether it is external factors (such as increased volatility) or because of personal performance, there are times when you have to be willing to step away (or run away) from participating in the markets. One salient example for active traders to step away is when things start to get emotional.  The very good or very bad trades create emotional responses that cloud objective decision making and skew perceptions of risk.   Traders on a losing streak inevitably end up taking trades that they wouldn’t ordinarily take to try and compensate for losses.  Likewise, traders on a winning streak tend to get overconfident and take trades they ordinarily would pass up because they feel they can do no wrong. Either way, when things get emotional, that is one red flag traders need to recognize as a signal to step back.

Lesson 4: never count your money when you’re sittin’ at the table

We’ve all grown up learning table manners, yet a very few of them have been as practical as this.  For most online investors, the fact that you count your winnings at the table isn’t so much a social faux pas (because nobody is there except for you) as it is a psychological one. Traders who focus on their profit and loss (P&L) during trading hours can typically become distracted by past performance instead of keeping their eyes on the market in front of them.  To toss another analogy into the mix, it is akin to a goalie staring at the scoreboard instead of keeping their attention in the game.  Looking at the money tends to provoke emotional reactions (e.g. ‘I made lots of money therefore I am smart, savvy etc) which as lesson 3 highlighted, leads to poor decision making and ultimately poor outcomes.

Lesson 5: every gambler knows that the secret to survivin’ is knowing what to throw away and knowing what to keep

Amazingly every gambler may know this secret (which doesn’t make it much of a secret) yet in spite of knowing it many gamblers fail to survive.  For investors, the advice is equally true.  Long term survival rests on being able to effectively manage winners and losers.  Behavioural psychology research has shown that the temptation to stay in a losing trade just a little longer or to exit quickly to take a profit is incredibly difficult for investors to avoid despite knowing better. Like any other skill, mastering holding and folding is something that requires practice and discipline.

Lesson 6: every hand’s a winner and every hand’s a loser

Even though it is not the most famous line from the song, this phrase professes a profound message: that victory or defeat is determined by more than just the hand you have but also by the players you are playing against. For investors, the particular investment may be “quality” but you also have to factor in the market conditions that you’re playing against.  The right stock at the wrong time or in the wrong market is still likely to result in a losing trade. Just like professional poker players, professional investors and traders learn to read the market they’re stepping into. Successful professionals use their understanding of the competition to evaluate what setups are likely to work and which are likely to fail based on who they’re playing against.