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.