Friday, April 06, 2007

What We Can Learn From Trading and Poker

A Google search for "poker and trading" yields quite a few articles on the topic. Indeed, I've found that many short-term traders enjoy poker and are quite good at it, including the world-class trader I recently wrote about. Let's take a look at some of the similarities between Texas Hold'em poker and trading and explore their implications:

1) Both are high-frequency performance activities - What this means is that motivated students have many opportunities to play many times in the course of a day. The high frequency nature of poker hands and short-term trades means that performers see many patterns in a relatively short period of time. This accelerates the learning curve. It also enables most poker players and short-term traders to be self-taught. They learn through repeated observation and experience. Seeing many hands in many different game situations and learning from your betting successes and mistakes is a great teacher in both fields.

2) Both combine elements of statistical edge with discretionary judgment - In trading, you can think of the markets leading up to your trading session as the cards you've been dealt. Sometimes your cards provide you with a strong edge. When the market recently sold off on record put/call volume, for example, there was a strong edge to the upside. Similarly, drawing two aces offers far better odds than drawing a 2 and a 9 unsuited. Neither the short-term trader nor the poker player will slavishly follow these odds, however. It's important to see what is happening in the moment; that is where discretionary judgment enters. A steep selloff on unexpected economic news will alter a trader's willingness to bet on a bullish market pattern. Subtle tells around the table will tell the poker player it's OK to bluff with a relatively weak hand. Poker players and short-term traders need to have an edge and know what it is, but they also have to be able to use real-time judgment as to when to proceed with so-so odds.

3) Both fields require disciplined money management - In poker, going "all in" can bring a quick score, but also a quick exit from the table. Sizing bets (trades) too large for one's stake can bring ruin on a series of losing hands (markets). On the other hand, both poker players and traders know how important it is to press an advantage when it's there. A large percentage of profits will come from a relatively small number of hands (trades). Staying in the game is key, but winning also requires aggressiveness when you've got the "nuts": the strongest hand.

4) Winning in both fields requires a willingness to not play - This is important. If you think of the prior market action as the cards you're dealt (the hole cards), market behavior as you're trading represents the new cards that are revealed (flop, turn, river). At any point, you can decide to bet or not bet, and you can decide how much to bet. Good poker players "muck" many hands; they don't bet when odds aren't on their side. Similarly, good traders will stand aside if they don't see a market that provides adequate volume and volatility. Knowing when to play--and how aggressively to play--is a major element in success for both professionals.

5) Winning requires that you know who you're up against - In poker, you'll bet differently at a small table than a large one. You'll bet differently in a local casino, playing against amateurs, than during the late rounds of a professional tournament. Over time, poker players learn the patterns of their adversaries and use these to make betting decisions. Similarly, short-term traders become sensitive to the impact of large market participants. They see if volume is entering the market on buying or selling and adjust their strategies accordingly. In that sense, both poker players and short-term traders must be shrewd psychologists: they try to get inside the heads of competitors.

Is this a hand I want to play? As the game is progressing, how is my edge changing? How much to I want to bet on this hand? Who is participating at the table with me and which way are they leaning? These are fine questions for poker players and traders alike.

12 comments:

heywally said...

For me, #'s 3 and 4 are the most important similarities - to win at tournament poker, you (usually) must fold lots of hands, especially in the early round(s). That equates to not trading except when you have the most favorable setups.

On the money management side, my biggest weakness in poker is going all-in in situations where I should just be making an oversize bet. I don't have that problem in trading (probably because the money is bigger). I generally have the opposite problem in trading - not taking enough risk at the right time.

D TradeIdeas said...

I agree that you've got to keep that Kenny Rogers tune in your head about "knowing when to hold 'em and when to fold 'em". It's like knowing when a blackjack shoe is hot or not.

Chris Perruna and I discussed similar ideas that make your points even more relevant - read for even more context.

Brett Steenbarger, Ph.D. said...

Hi HeyWally,

Very interesting observation. I would have guessed that one's flaws in poker would be one's trading flaws as well, but you've described the opposite pattern! Shows how much the shrink knows... :-)

Brett

Brett Steenbarger, Ph.D. said...

Hi David,

Thanks for linking to your post re: Chris Perruna's observations. Very insightful. I recommend Chris' blog site as well.

Brett

MIsstrade said...

I particularily like Point 4 and would have that as the number one point. The most successful poker players and traders I know, take time away when opportunities don't show themselves, and are fine with that sequence of nothingness. It is that patience and knowing that the next trade will be around the corner that makes them perform, sometimes not trading is my best trade. Poker you must fold all day to win, and that is why most "retail" poker players lose because they watch tv poker and see only the all in hands, not the 1900 hands before those that the winners folded with. Great marketing but not good TV to watch players fold. Its the same with trading, most solid traders, are schooled in the fact that they must fold or not play and wait for their setups to win over time.

Brett Steenbarger, Ph.D. said...

Thanks, Misstrade, for an excellent comment. Not trading, indeed, is often the best trade. Too many traders are more interested in action than in making money--

Brett

Dinosaur Trader said...

I'll second what misstrade said... that #4 point is so important. I think it's also the one I commonly have the most difficulty with. I have a really hard time staying on the sidelines.

To quote a lyric by Radiohead...

"there's always a siren singing you to shipwreck."

Typically, I really hate comparisons between the market and gambling, perhaps because they're often way off base. People who don't trade for a living or who don't understand the way the market works think it's all luck. If the Dow is up, they think I had an easy day and just raked it in... that drives me nuts.

However, the poker comparision is a good one for all the reasons you point out, Brett. There's a lot more skill involved in poker than in pure games of chance.

Brett Steenbarger, Ph.D. said...

Hi Dinosaur Trader,

Great Radiohead quote, and very relevant to trading. Thanks. The combination of self restraint and aggressiveness that is necessary in poker is also a key element in short term trading. It's a rare combination--

Brett

Simply Options Trader said...

Hi Dr Brett,
There is indeed much similarities between trading & poker. I share my views in Daytrader Stuns Pros At Asian Poker Finals.

Brett Steenbarger, Ph.D. said...

Hi Simply,

Thanks for that link!

Brett

Simply Options Trader said...

Hi Dr Brett,
The previous link is not working. Here's the right one. Thanks.
Daytrader Stuns Pros At Asian Poker Finals

danbuffer said...

The best technique to win a poker game is to know its basics.. understand the cards and their value... and most of all "BET SMART".

Anybody can win if they are smart enough to win against their opponent.


dan

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