The quest of financial security for the present and the future is a basic tenant of our contemporary lives. One of common reason for not investing is the fear of making mistakes that will result in losses instead of gains. There are many investing tips; one of the important ones for new investors to learn is that everyone makes investments that lose value.
In an attempt to avoid losses, investors will choose “safe” investments, such as money market funds and savings accounts. While safe investments should be part of any financial strategy, they should not be the sole player in that strategy. The basis of successful investing is the use of a number of fundamentals. One key concept is the understanding of risk versus reward. “Safe” investments which carry almost zero risk. The return on those investments, especially over the last couple of years, has also been near zero as well.
Another fundamental that is required is the understanding of basic mathematical principles. Many new investors think that in order to be successful trading stocks, approximately 70 to 80% of their choices should show profit. The number is actually substantially smaller. If out of ten trades, four show a profit of $2,000 and the other six show a loss of $1,500, the investor still enjoys a profit of $500.
Investment professionals will stress another attribute that is a part of every successful investor’s strategy: patience. Those who achieve their desired level of success are the ones who take a long-term approach. Looking for the “big, quick score” routinely results in taking on far too much risk.
Looking Far from Wall Street for examples Investing concepts, like P/E ratios, hedge, yield, and averaging down, can be somewhat intimidating to new investors. However, in one’s attempt to learn the trade in practice, there is a popular and simple activity that can teach the fundamentals and offers concrete examples of why they are sound; blackjack.
Use Sound Mathematical Concepts
Blackjack strategy is based on sound mathematical principles. You will often hear players at a blackjack table say “the book says” when they are deciding on a course of action. The book they are referring to is Beat the Dealer by Edward O. Thorp, the most fundamental of blackjack guides, even though many players have probably never read it.
Thorp is a mathematician who spent endless hours running computer simulations and performing calculations to determine the mathematically correct action for every possible two-card player hand and for every possible dealer up card. Thorp’s calculations resulted in what is commonly known as “basic strategy.” When used consistently at the blackjack table, the house edge drops to less than 1%. Thorp approached blackjack as a strictly mathematical exercise. He is credited by many as being responsible for the popularity of the game today.
Other mathematicians, such as Peter Griffin and Julian Braun have spent a great deal of time analyzing the game as well as a great deal of time at the green felt tables. Like Thorpe, both academics are members of the Blackjack Hall of Fame, which is hosted by the Barona Casino just outside of San Diego.
Risk versus Reward
Basic strategy in blackjack is a perfect example of risk versus reward. Indeed, some actions may seem “risky” at first glance.
For example, basic strategy says that you always split 8s. When the dealer is showing a face card or a nine, the idea of risking twice the original wager may seem like a risk. However, mathematically it is the best decision one can make. A sixteen is frequently a losing hand. Splitting the 8s makes it possible for the player to win both or a win one/lose one result.
One extreme example of risk versus reward is found in the story of Don Johnson, who is known as the “man who broke Atlantic City.” Johnson, a wealthy business owner, is known as a “whale” in casino terms, meaning he was willing to bet huge sums at time. In his case, that was usually in the neighborhood of $100,000 per hand.
Casinos make many accommodations for such high rollers; free suites, private jets to fly them to and from the casino, and other amenities. Johnson was able to negotiate a deal where the casino would give him a discount of 20% on his losses. With blackjack’s already low house edge, it meant that Johnson was playing with about a 19% edge over the house. The casinos were willing to take the risk based on the amount Johnson was willing to risk. In only six months, he won $15 million playing blackjack, an enormous payout that lives on in blackjack history to this day.
Surrendering and Doubling down are similar
Players can surrender their hand at the cost of one-half of their original wager. This is common practice when the player has a 16 against a high dealer card.
Players can “double down” by doubling the amount of their wager and taking only one additional card. This is most common when the player has a 10 or 11 and the dealer is showing a low card.
Both are examples of ways to take advantage of risk versus reward. Surrendering reduces the risk when the odds are unfavorable. Doubling down allows the player to increase reward (payout) when the odds are favorable with little additional risk.
A Long-Run Perspective
The fact that a particular outcome will occur 90% of the time means that it will not occur 10% of the time. That means that if a player makes a $10 wager on the exact same hand for 10 hands he will show a profit of $90. The key is to take the long run perspective. Basic strategy does not guarantee a winner every hand, but will show a profit over the long run.
The Investing Correlation
These concepts in blackjack have direct counterparts in the investing world. Basic Strategy is not that dissimilar to investing based on research and knowledge of the fundamentals.
Risk versus reward translates into giving yourself the best chance of a favorable result with minimal risk. Everyone has heard stories of people who turned a $10,000 investment into millions. The number of times this has resulted in a large or total loss are not as well publicized.
Investing in a stock that has strong long-term fundamentals means the investor doesn’t bail out due to a temporary downturn. In order to succeed, those fundamentals are crucial, and need to be almost instinctive. Playing blackjack is a great way to make them a basic part of one’s overall outlook.