When an online poker firm published analysis of 120 million starting hands (hold ’em) played through its website, its analysis showed that of the 169 non-equivalent beginning combinations only 40 were found to be profitable. Furthermore, half of all profits were attributable to five hands (AA, KK, QQ, JJ, AK-suited). Given this skewed distribution of outcomes a winning strategy seems immediately obvious, but all is not quite what it seems. Why is this the case, and what does it mean for investors?

An initial glance at the data might lead us to believe that the optimal approach is simply to avoid making large bets until we are dealt a hand with a disproportionately high probability of success. The problem of course is that in a game of poker we do not make decisions in isolation – other players will observe and react to our behaviour.

If we were only placing bets of consequence when we had extremely strong hands, it would be incredibly easy for most players to spot this. Our seemingly optimal strategy would quickly become the obverse.

Similar to poker, there are not likely to be that many investment situations where the odds of a positive outcome are firmly on our side, but unlike poker most of us don’t have to worry about other investors directly anticipating our behaviour and compromising our returns. Does that mean investors are free to wait for those the most attractive of setups – the proverbial ‘fat pitch’?

Unfortunately, it is not that straightforward. There are three reasons why:

– We are not sure what a strong hand is: Identifying circumstances where the probability of superior performance is elevated is not simple. In poker it is evident when we have a strong hand, but in investing there is inherently more uncertainty and variability through time. (Somewhat ironically, the most attractive situations are likely to arise at times of valuation extremes – the exact point where we are likely to believe that the odds of a positive outcome are poor).

– We will misjudge when we have a strong hand: Our conviction will almost inescapably be driven by what has performed well in the recent past, particularly if it is supported by a persuasive narrative. This will create the perverse scenario where our confidence increases as the likelihood of a good result decreases. Unfortunately, we are more likely to bet big on a bad hand.

– We will play too many hands:  In poker we need to play more hands than might seem ideal to keep other players from predicting our behaviour; whereas in investing we trade more than we should because there is an expectation that we need to be constantly active. The investment industry rewards heat not light. Markets are noisy and chaotic, perpetually generating new stories and discarding old ones. Each month or quarter the focus will be on a shiny new topic, and we are expected to react. There is a bizarre value attached to being a busy fool, with very few investors afforded the luxury of time and patience.

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The inherent unpredictability of financial markets allied to our own behavioural foibles means that investors are vulnerable not only to playing far too many hands but also increasing our stake as the odds deteriorate. Although this is a path to poor returns it does give us plenty to talk about while we get there.

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My first book has been published. The Intelligent Fund Investor explores the beliefs and behaviours that lead investors astray, and shows how we can make better decisions. You can get a copy here (UK) or here (US).