Warren Buffett once said: “I am a better investor because I am a businessman, and a better businessman because I am an investor.”
We feel exactly the same way about poker and trading. As Jack’s poker alter ego recently tweeted:
After seven years of exploring connections between poker and trading, they still get stronger and deeper – which makes perfect sense I guess.
Both = zero sum games against flawed human competitors favoring courage, discipline, creativity, deep analytical ability, and risk control.
There are so many profound poker / trading parallels… one such is the truth of what an “edge” looks like, and the way it compounds via decisions over time.
Another incredibly powerful poker-trading parallel is the reality of the 90/10 profit distribution. If you aren’t familiar with this, you should be. (We plan to explore 90/10 implications — which are MASSIVE — on a much, much deeper level in future installments of the MT Driver’s Manual…)
Today, though, I want to make a third observation — and rant a little bit — in respect to a common misconception in trading… a conceptual error of sorts that poker can help shed light on.
First the rant:
Traders waste a lot of time on stupid / useless predictions. What do you think stock ABC is going to do? Where do you think the S&P 500 is going to go? What’s going to happen after Bernanke makes his speech on Wednesday? Will stocks be higher or lower by Christmas? Yeeaagh!
Most of this is a straight-up WASTE OF TIME. If a line of inquiry has no direct or indirect bearing on your P&L (profit and loss) — i.e. if an information pursuit does not inform your practical process in some way, or lead back to a P&L enhancing course of action in your trading account — then why are you expending energy and effort? Are you bored and looking for entertainment?
In that case, you may not be a serious trader… because serious traders understand there is ALWAYS a scarcity of time and energy relative to the myriad opportunities available to research and investigate… and the opportunity cost of spending time in front of a screen vs other quality-enhancing endeavors in life… thus leaving ZERO rational time allocation for herp-derp prediction inquiries of nil practical benefit!
To reiterate: Traders waste a lot of time, energy and effort on stuff that has NO BEARING on their P&L at the end of the day / month / quarter. This waste often takes the form of pointless questions. Where do I think TSLA is going to go? I don’t know, I’m neither long nor short, so why should I expend energy on a question that vague when I can instead focus on trying to find the next high conviction opportunity where I actually intend to take a sizable position?
How high do I think crude oil will go before it tops? Again, I have no frigging idea and nor does anyone else, there are literally a thousand variables that could impact the blow-off, no, make that ten thousand, so trying to guess exact timing and magnitude makes zero sense, and again, crude oil as a conflicted trade is in the “too hard” bucket right now, I’m not focused on it, so why waste my time…
Traders are ridiculously enamored with the quest for certainty — the impossible safety blanket of “knowing” what is going to happen. Are you certain the scenario you just laid out will come to pass? How do you KNOW that it’s going to be correct? Can you kindly confirm 100% confidence, so I can completely absolve myself of personal responsibility for the risk I am taking? Hey, something different happened – last week you said X was the probable outcome and it turned out to be wrong! What gives!?!?!
Show me a trader who is obsessed with guessing the future, noodling over noise factors that have no bearing on actual trading decisions, and constantly in thrall to false certainty, and I’ll show you a stumbling neophyte hacker with no true understanding of probability (on a philosophical level, and perhaps a math level too) who is most likely faring quite poorly in markets.
If that sounds painfully familiar, here is some good news: It’s a description that fits nearly all traders at some point in their career… and it’s always possible to change.
The further good news is as follows:
You don’t need a crystal ball to do well as a trader.
You can ignore the endless deluge of pointless shit most traders pay attention to.
You don’t need certainty — ever. Probability alone can keep you in clover.
In other words: If you think trading is about knowing the future, you are missing a key point in respect to probability, experience, and scenario gaming.
Forever Incomplete Data Sets
The habits and training of the professional poker player are instructive here. Consider the following:
The skilled poker player never has full certainty… because he never gets to see his opponent’s hole cards.
What’s more, the skilled poker player never has advance knowledge of what cards are coming on the turn or river — he only has the valuable ability to estimate probabilities… and game various scenarios based on situational context.
Assuming there is no cheating going on, a world class poker player never has full information. Ever. His data set is always imperfect.
Worse still, our hero never has certainty as to what cards are coming on fourth or fifth street — only probability estimates based on information available.
And yet this same player, so “handicapped” by a lack of certainty and lack of information, can extract sizable and consistent profits from his opponents, over and over, with clockwork regularity over time…
How is this possible?
Games of Expectation
The answer, above and beyond the cumulative impact of superior decision making, is that poker is a game of expectation, and so is trading. When you realize the deep implications of this, you stop worrying about certainty (and perhaps stop trying to predict the future too)…
By expectation we mean positive and negative expectation, roughly defined as follows:
POSITIVE EXPECTATION: In a poker or trading setting, if you take action ABC under a given set of circumstances, and the full range of probabilistic outcomes is played out over thousands of repeated trials, leading to a net profitable result on balance and on average over time, then ABC, as a course of action, can be said to have positive expectation.
Shorter version: If you took this action 1,000 times over, would it be profitable on a cumulative basis? If yes, it is +EV (has positive expected value).
NEGATIVE EXPECTATION: The above in reverse. If you take action XYZ under a given set of circumstances, and the full range of probabilistic outcomes over hundreds or thousands of trials leads to a net unprofitable result, then XYZ can be said to be -EV (have negative expectation).
Simple math example:
A math-challenged gambler approaches you and proposes the following:
You roll a six-sided die as many times as you want. If anything from 1 to 5 comes up, you pay the gambler $10. But if the 6 comes up, he pays you $56.
You gladly take the wager, because assuming it is a fair die, each roll has a positive expectation of $1.
Imagine if you rolled 1, 2, 3, 4, 5, 6 to hit all sides of the die in sequence. Your first five rolls would cost you $50. Your sixth roll would earn you $56. Your net $6 profit, distributed over six rolls, is $1 per roll.
Now forget the ordered sequence. It doesn’t matter what order the numbers come in. If you roll enough times, your expectation still comes out to $1 per roll. This is simple probability at work.
You can also see this with standard math: A 5/6 probability of losing $10 equals expected loss of ~$8.33; a 1/6 probability of gaining $56 equals expected gain of ~$9.33; net the gain and loss for $1 per roll expectation.
Note that expectation says nothing about distribution. If you are lucky you might start out rolling three sixes in a row, to quickly move ahead by $168. If you are unlucky you might not get a six in your first 20 tries, and fall behind by $200.
But even with such swings, your long-run expectation, assuming the die is fair, is still $1 per roll…
The point here is more philosophical than mathematical:
Poker and trading are games of expectation, which means all actions can be viewed as net P&L accretive or net P&L dilutive via repeated trials over time.
When you really understand what this means, you no longer worry about trying to predict the future, or gain false certainty, and instead focus on gaming scenarios and making positive expectation bets, over and over and over again.
You see a poker player make a gutsy move and drag a $2,000 pot. Was that a smart move? Can’t say — you don’t have enough information.
If the player’s move had a negative expectation, given all the particulars of the scenario, then it was not a smart move. It was a move that just happened to pay off in this instance, but will cost money in the long run, offering a short-run payoff that will not last.
This is comparable to the gambler in our dice-rolling scenario who pays out $56 on a six. Maybe this guy collects $10 from you 20 times in a row before your run of sixes comes. Does that make him smart? He may look smart while he is collecting that $200, but in the long run he is guaranteed to lose…
Flip the question around. You see a poker player call make a very large turn bet. You see him get called and then proceed to lose a $2,000 pot. Was that a bad / stupid turn bet? Again, you cannot say. If it was a positive expectation move, given all the information in that given situation, then such a move will be profitable on balance over time… and in expectation games, the results over a long series of repeated trials are what matters.
“Okay, okay,” some of you are muttering. “Poker and trading are games of expectation. Why does any of this matter?”
It matters because once you really understand this, you will STOP WORRYING ABOUT TRYING TO PREDICT THE FUTURE, and start learning to think in terms of probabilistic outcomes.
Something else to ponder:
Experience is a huge, huge asset in poker and trading. Gigantic. But why is experience so valuable in both games?
Not because experience helps you predict the future… but because experience helps you properly game scenarios and thus arrive at accurately discerned probabilistic outcome junctures.
What does that mean? Well, think of it like this:
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