What investors can learn from big dawgs at the casinos

April 25, 2014, 6:02 PM UTC
Placing your bets.

FORTUNE — There are three big lessons that all investors could learn from professional gamblers.

That was one of the first things I learned when I went back to school this week. The Wisconsin School of Business, located at the University of Wisconsin-Madison, runs a program for visiting business journalists. Each semester, they invite one down for a packed few days — meeting with professors about their research, touring the facilities, chatting with students about the work they’re doing as well.

For the record, I lived in Madison until age 11. My father, Chuck Sherman, was — I’m told — a rock star communications professor. But I haven’t been back for nearly three decades. And I had no idea what was going on in the business school. It’s an interesting model: Students choose to specialize in one of 10 “Knowledge Centers,” including marketing research, brand management, and — the place I started my day — securities analysis. They’re taught by a combination of academics and folks recruited after years in their respective fields.

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The pearl about investors and gamblers came from the mouth of Mark Ready, chair of the department of finance. It made his colleague Brian Hellmer, a former portfolio manager and director of the Hawk Center for Applied Security Analysis, cringe. “We don’t want to reinforce the casino gaming mentality of investing,” he said. (He doesn’t believe stock market games belong in financial literacy classes for that reason.) But digging a little deeper, he and Ready agreed that there are in fact a few things that could help investors — not day traders, not market timers, but individual investors trying to get from where they are to retirement — improve their performance.

1. It helps to understand the odds. In other words, investors would benefit from a deeper understanding of probability, Ready says. Too many can’t distinguish between luck and randomness. “They see meaning where there is none.” The most common example: short-term price changes. “There is a lot of noise there,” he says. “You can have a very good [investment] process and still not get it right.” He also notes: Being right once is the same as being wrong once. The former doesn’t make you a genius. The latter doesn’t make you an idiot. It’s your overall track record that counts.

2. Look for the outliers. Most investors don’t focus enough on this, Hellmer says. A professional football gambler spends most of his time not figuring out how much to bet on each of the games happening on a particular Sunday, but on figuring out which game to bet on, he says. Why is that? “Most of the odds are correctly set, most of the games are correctly priced. What you’re looking for is the one game that’s mispriced.” Good investors benefit by doing the same thing — trying to take advantage of a stock’s (or the market’s) overreaction to bad news or even the tone of the news.

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3. You shouldn’t change your strategy based on one or two outcomes. How does a card counter beat the casino? Not by winning every hand, Ready explained, but by tallying up more wins than losses overall. The same applies to being the sort of investor with the ability to consistently outperform. That means closing your eyes to the daily, weekly, even monthly volatility, and focusing on the long-term performance. It’s hard to do, Hellmer notes, even for high-net-worth individuals. If you’re the sort of self-directed investor who’s tempted to sell rather than add to your position after a particularly bad stretch in the market, it also argues for scaling back the amount of time you spend perusing your portfolio — or getting professional help.

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