“If you can’t spot the sucker in the first half hour at the table, then you ARE the sucker.”
–Matt Damon, Rounders
I used to play online poker. A friend of mine had shown me his screen playing Texas Hold ‘Em in the first year of business school, back in 2001. I had played the family version of penny ante poker as a little kid, so I knew the rules, but I didn’t realize that you could play other people online for money. Wow.
There was one minor problem. As the British would say, we were skint. While my law school summer internship had allowed us to slay the demons of credit card debt, we weren’t exactly rolling in free cash flow. So, I had to play the free games.
The way that these sites got you hooked was to offer free games and these enormous tournaments where the last few players remaining got a little bit of real money in their accounts. It was usually the top 10, and the winner would get something like $10. If you think about all of the time required to play a knockout tournament of 2,000 players just to try to win $10, the ROI of the time was ridiculously low (to see how Monkey Brain overvalues free items, you can subscribe to my 52 Week Game Plan. It’s free…and you won’t overvalue it!). However, since I didn’t feel like I could justify gambling even $10 to my wife, I plugged away until I won.
Eventually, I took that $10 and parlayed it into a pretty healthy bankroll. I paid for quite a few vacations and a couple of entries into the World Series of Poker (and, yes, I claimed my winnings on my taxes).
Was I some phenomenal player who was mopping the floor with the whales? No. What had happened is a phenomenon expertly explained by Michael Maubossin in his article “The Paradox of Skill: Why Greater Skill Leads to More Luck.” Top poker players rely on what they call “dead money” for their profits. The house – either the website hosting the poker or the casino – takes its cut off of the top of every pot. It’s called the rake. So, if there’s a pot of $10, the casino will take fifty cents, and leave everyone playing for $9.50. If you take ten people who are equally skillful, then, over time, they’ll all get their run of good and bad cards, and they’ll cancel each other out. Nobody wins except the house.
That’s why good poker players rely on bad poker players for their profits. Think of the rake – the casino’s piece of the action – as a constant leak in a tub of water. In order for you to continue to be able to take water from the tub, you need a faucet supplying new water. That’s what bad (mostly new) players are – they’re the supply of new money which the more skillful poker players are able to extract from them.
As long as Internet poker was booming, then there was going to be a steady stream of the uninitiated, falling victim to the Dunning-Kruger Effect, where you think that you’re better than you are at something. If all you needed was access to your credit card to fund your playing account, a little bit of bravado, and some naiveté, then the skilled at the poker table could continue to fund themselves.
However, once Congress passed the Unlawful Internet Gambling Enforcement Act (UIGEA), the world of online poker changed. No longer could regular players count on the uninitiated to provide an endless stream of new, dead money. The flow of water from the faucet had stopped, and the endless drip from the tub in the form of the rake continued apace.
Compounding the problem was the proliferation of information about how to get better at poker. At one time, Super System from Doyle Brunson was the only real, comprehensive book about strategies of poker. While it was commonly read by the skilled players, its general penetration in the greater poker playing community was fairly limited. New sites such as the Two Plus Two forums and PocketFives popped up, and, soon enough, the barrier to entry for learning enough information to make you a solid poker player had been reduced to nearly nothing. With a few hours of research and a commitment to hours of playing, it wasn’t difficult to become a fairly skilled poker player.
This is where the paradox of skill started to take over. The overall skill level of the entire online poker economy had increased dramatically, and the spread between best player and worst player shrunk in proportion. The flow of new people at the wrong end of the tail – the least skilled – had stopped. The average skill of the bottom 5% who were getting lopped off each year continued to increase, while the ceiling of skill never really changed, as, theoretically, there is an upper limit to the amount of poker playing skill one can actually possess.
As the paper explains, when there is a decrease in the standard deviation of skill in a community, then the impact of luck will become more and more disproportionate. When there is wide variance of skill, then either luck or skill can account for exceptional performance. When there is narrow variance in skill, then skill rarely accounts for exceptional performance, and it falls to luck to change one’s fortune.
How does this relate to investing?