Bringing Down the House - What Blackjack can teach us about investing.

If you have read the book "Bringing Down the House" by Ben Mezrich or seen the movie "21" based on the book, then you are at least familiar with the system employed by a team of MIT students to beat the game of blackjack.  For those that have not seen the movie, the system is simple.  You have players sitting at several of the blackjack tables in a casino keeping a cumulative count of +1 for cards 2-6 and -1 for 10-Ace (cards 7-9 are 0 points).  The objective is to find tables with high positive counts, or said another way, a disproportionate amount of 10-Aces left to be dealt.  These tables have a very large positive probability-weighted return, so if you can find 10 tables with 10+ counts you would allocate a large portion of your total capital.  If every table has a negative count you don't bet or allocate any capital. 

The Good Investor's Mentality - Do you have it?

This quick test will tell you if you have the mentality of the world's greatest investors:

1)       A blackjack player has 19, takes a hit and gets a 2 for 21.  Is the decision to take a hit a:

a.        Good decision

b.        Bad decision

2)       You buy a house for $1 million that subsequently declines in value to $500,000.  Someone offers you $800,000 for the house.  Do you:

a.        Take the deal

b.        Pass

3)       Two stocks trading at $30 have the same potential upside to $50 and downside to $20, but you have greater confidence in the upside being achieved for Stock One.  Assuming all else equal you would:

a.        Have a greater exposure to Stock One

b.        Have equal exposure to both assets

4)       You should let winners run:

a.        True

b.        False

5)       The five best ideas in your portfolio from a risk-reward standpoint should be your five largest positions:

a.        True

b.        False

6)       The best measure of risk for an asset is:

a.        Downside potential

b.        Volatility

Michael Lewis / David Einhorn article in NY Times

Michael Lewis and David Einhorn recently wrote a two part Op-Ed article in the NY Times titled "The End of the Financial World as We Know It" and "How to Repair a Broken Financial World." In it they discuss the precarious position of the status of US financial markets as the bastion of high financial thinking in the global economy and how current events have permanently impaired that image. 

However, I believe the most interesting aspect of the article is the amazing story of Harry Markopolos who for the last decade has tried to get the SEC to investigate Madoff because as he stated in a November 2005 letter to the SEC, "it is highly likely that Madoff Securities is the world's largest Ponzi scheme."  To backup his case he outlined 29 RED FLAGS!  With this detailed case in hand, the SEC let repeated attempts by Markopolos to blow the whistle slip by.