As I mentioned previously, one of my hobbies is playing poker and I can do it for free online. When I visit a casino and play poker, I usually make money. However, I used to have trouble making money when I’m playing with a lot of bad players. The problem is that they all stay with me and one of them often gets a good draw (because there are so many of them) that I get beaten.
The secret to overcoming this is to really play conservatively. Get out of every starting hand that doesn’t give you at least a 30% chance of winning the pot. And get out of the good hands that don’t develop well after you’ve seen three more cards.
What happens when you do this is that you really cut your losses short. On most hands, by folding at the beginning, you won’t lose any money at all. And when you do play a hand, even if everyone else stays in the pot, you still know you have at least a 30% chance of winning. And if you risk $20 along with nine other players, you have a pot of $200. You have a 30% chance of winning that pot (i.e., your expectancy is $200 times 30% or $60), but it only cost you $20 to get that advantage. If you do that a lot, you’ll make a lot of money.
Furthermore, when you do get a good hand and it develops into something very good, then bet it heavily. You’ll chase out many bad players and others will be calling you on long shots. You’ll be playing hands that give you an 80% chance of winning, risking the same money as let’s say two opponents who each have a 10% chance of winning. But they put in the same amount of money as you did. Don’t you like those odds?
For example, suppose you start out with an Ace King of the same suit which has a 68.6% chance of winning the final pot. Three common cards are dealt and you get an ace and two more hearts. You now have the strongest pair on the board and you have the potential for an even stronger hand – five hearts. Your odds of winning this pot are very good and you should bet accordingly. Let’s say you bet $50 and two other people match you. There is now $200 in the pot from the first round of betting and $150 in the pot from the second round of betting. There is $300 in the pot and you now have an 80% chance of winning it, so your expectancy is $240. However, it only cost you $70 to get that expectancy of the first two rounds of trading. Now your situation is even better.
So let’s look at a similar trading situation. You find a stock which is selling for about 65% of its liquidation value. (If you don’t know how to do this, I’d recommend you read about the Graham’s number strategy in my book Safe Strategies for Financial Freedom). Not only is the stock cheap, but it has been moving up for the last two months, so it is moving in your favor. This is a trading situation is equivalent to getting an Ace King of the same suit as a starting hand in poker. In fact, it’s better because your odds of making money in this trade are probably much better than 68.8%.
So you want to make sure you take a strong position in a stock like this. Let’s say you have a $100,000 account. You invest $5000 in the stock, knowing you’ll stop out if you lose $1000 of the $5000. Thus, you are only risking 1% of your equity on the stock.
Once you are in the stock, it continues to move in your favor. Within three weeks, the stock has moved up 33%. If it retreated down 20%, you’d get out to preserve your profits, so you are basically guaranteed that this trade will now be a winner. This is equivalent to getting a really good draw on your poker hand when you feel almost certain that you will win the pot.
In poker, you’d probably bet heavily on the strong hand. And in trading, you want to make sure that you give this stock plenty of room to move so that it has the potential to make you a lot more money. It’s the second part of the Golden Rule of Trading: Let Your Profits Run.
