Big edges don’t exist: A Poker Analogy

I didn’t have time before my trip to Las Vegas to write another blog post on the theme of poker and trading so here it is now. In this blog, I’d like to talk about some similarities that show how both poker and trading are more difficult than they seem.

The aim in both pursuits is to find and then exploit an edge. Let’s consider a poker edge first. In this post, I want to focus on the Continuation Bet, which was first popularized by Dan Harrington in his 2004 book, Harrington on Holdem. It was a tactic that was already known by many professionals but was entirely new to most casual poker players.

The continuation bet (or c-bet) is a bet made on the flop by the pre-flop raiser, often as a bluff. This bluff usually works because of a simple truth: most flops miss most hands most of the time. Specifically, your hand will connect with the flop in a meaningful way only about 1/3 of the time.  The same is true for your opponent’s hand. So, if your opponent plays a “fit-or-fold” strategy on the flop (as most players did in 2004), the continuation bet is a license to print money.

If you are the pre-flop aggressor and bet $10 into a $20 pot on the flop as a total bluff, you can see that this bluff only needs to work 1/3 of the time for you to break even on the bet.  Your “fit-or-fold” opponent though will miss the flop 2/3 of the time and fold.  This means you can make a continuation bet on every single flop and make huge profits even if you give up on the pot every time your bet is called – and the icing on the cake is that sometimes you will actually have a real hand. Easy game.

So, what’s happening is that a particular behavior pattern is observed (most people fold too often on the flop) and a strategy is constructed to exploit this behavior: bet the flop regardless of your hand. Isn’t this precisely what we aim to do as traders? We pore through charts or perform backtests in order to find repeating patterns of market behavior that we then exploit by constructing setups. An example of this is found on this website: markets tend to alternate between phases of trend and balance. Fading the extremes of a balance provides an edge because a balancing market tends to oscillate from one extreme to the other enough of the time to produce a long-term positive expectancy. It sounds like a simple solution to your trading – just buy below value and sell above value every time a balance appears on a chart and watch the money roll in. Easy game.

If trading were really this easy, why is it that we read that 95% of traders lose? Why do so few poker players make a long-term profit? Because your opponents in poker are not all unobservant idiots and your trading opponents are most certainly not all idiots. Easy money is always hard to find.

The beauty of the continuation bet is that it’s simple to learn and execute: just raise pre-flop and then bet out on the flop.  You don’t need any talent to do this, nor any deep understanding of the complexities of the game, but you should recognize that, like any exploitative strategy, overuse of the c-bet leaves you open to an exploitative counter-strategy, which in this case is The Float.

The c-bet on the flop is commonly a “one-and-done” tactic: if the c-bet bluff encounters resistance then just give up and check-fold the turn – the money made when opponents do the decent thing and fold more than makes up for the times when it fails.  The c-bet exploits the tendency of opponents to fold too often on the flop so… Don’t Fold! Call the c-bet on the flop regardless of your hand. The Float exploits the c-bettor’s tendency to check on the turn and then fold to a bet. After calling on the flop with any two cards, you can simply bet when the c-bettor checks the turn and expect your opponent to fold most of the time.

You can see how the edge in c-betting is eroded over time as observant opponents no longer fold enough of the time for a c-bet to be insanely profitable. Don’t get me wrong – c-betting as a bluff is definitely a good thing to do but not to excess and it can’t be the only weapon in your arsenal.  If you’re following the logic here, the Float is similarly exploitable if overdone: the error is that of calling too wide on the flop; the exploit is the double-barrel bluff on the turn by the original c-bettor. And so on.  The game is always in a dynamic state of evolution as exploitative strategies are identified, gain currency and are then themselves exploited by a counter-strategy. Perhaps, poker is not such an easy game, after all?

The same is true in trading. Traders recognize repeating patterns of market behavior, those patterns gain currency as more traders seek to exploit them and then they lose their potency as other traders find that more success can be had by fading those patterns.  Any easy-to-find edge has long since been eroded to become a 50:50 proposition if you try to apply it thoughtlessly in all circumstances.

This observation applies to the Auction Profile method on this website too. The phenomenon of markets alternating between balance and imbalance is not exactly a secret known only to a few. It is not a secret that the market displays inertia: that trends tend to continue (that’s why they are called trends), and that markets in balance tend to oscillate. But, you should not expect to be able to blindly fade every extreme in every balance on every chart and make exceptional profits. This is akin to c-betting 100% of the time. Certainly, I believe that there is an edge to be gained from fading the extremes of balances but, like all edges in trading, it is necessarily small.

Any method – in trading as in poker – that exploits a particular pattern of behavior is itself exploitable by counter-strategies. You should therefore not be surprised when you are shaken out of your position by a false breakout – this will happen. Your trading opponents have simply floated your c-bet. But this provides many additional profitable opportunities though if you can learn to recognize a false breakout: you can execute the equivalent of a double-barrel.

The main lesson from this poker analogy is that you should not expect trading to be easy. There are no easy exploits and all trading edges are small – big edges just don’t last long. Just as good poker players get inside the heads of their opponents and sniff out weakness, good traders learn to read the mind of the market and sense when the longs or shorts are weak. To this end, the primary goal of the Auction Profile software is to give you a framework within which to understand the mind of the market. You should use it to try to understand what Auction Market Theory tells us about the mood of the market as revealed on the chart and be discerning when selecting trades.

As a final note, if you were wondering whether my Vegas trip was successful, well it didn’t work out quite as I had hoped. I entered one WSOP Circuit Event at Planet Hollywood and two of the Venetian Deep Stack Extravaganza events, including the Main Event. I made one minor cash (25th) at the Venetian. I thought I played well enough overall but I’m sure I made many more mistakes than I recognized at the time. Like most of us, I left Las Vegas richer in experience, lighter in pocket but with one abiding thought: I’ll be back!

As always, trade well and run good.


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