Tuesday, March 15, 2005

Gamblers call it variance, finance quants call it gambler's ruin.

Whatever you call it, it lurks just around the corner from your bank roll.

A professional manages their investments with a constant look at the value of their portfolio. For volatile speculations variance requires that you consider putting only a small amount at risk in similar investments.

This fits the poker table. At the end of a tournament, the player with the smallest stack is probably going home next. At a 15-30 ring game, the player with a small bank roll may be about to lose it all.

The Rush, the bad beat, good luck, and suck out. If you flip an honest coin a million times, you get that 50/50 split, but the next flip could be heads or tails. Somewhere in those million flips there were runs of 50 or 100 heads in a row, same for tails. You don't know in advance where those runs will start, or what character they will take. So what?

You can be the best player at a table due to good table selection. You will play with the same cards as the worst player at the table. You can go home the loser and he the winner, for weeks at a time. You need a big enough bank roll, or a small enough game, to survive this string of tails. If not, this is one gambler that met his ruin. The head side of the coin? The worst player may quit his day job thinking poker is easy money.

There is a lot written on portfolio size or bank roll size and surviving gambler's ruin. Skalansky's Theory of Poker is a good start. Hear from several financial practitioners in Jack D. Schwager's Market Wizards.

Read the book before you make the investment.

Don't let variance put you out of the game and send you home.

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