As I’m currently planning my upcoming pilgrimage to Vegas to overdose on poker for 10 days, I thought I’d share some musings about the similarities and differences between poker and trading. This was actually the source of the two most important insights I have ever had about trading.
My first trading epiphany occurred many years ago. As I recall, I entered a long trade (can’t remember what I was trading) and almost immediately regretted it. This was actually pretty normal for me at that time in my development as a trader – I didn’t have a trading plan, nor any clear idea what I was doing to be honest so my anxiety on this particular trade was not an anomaly. After I entered the trade, for whatever half-assed rationale that passed for analysis, I remember focusing obsessively on the tape, my emotions swinging from elation to despair with every up and down tick. After what seemed an eternity of frantically sitting on the edge of my chair, I eventually couldn’t take any more and impulsively marketed out for a loss. I was in the trade for less than 10 minutes, a little less than eternity. I lost around $80. Eighty dollars! I stood up and uttered a primal scream. How could I possibly get so bent out of shape for such a trivial amount of money?
Eventually, I stopped screaming and started thinking. At that time, my regular poker game was $20/$40 Limit Hold-em – this was before NL Hold-em became popular as a cash game. To put the trading loss in perspective, I had lost around 2 big bets, an amount that wouldn’t even register in my mind as a loss. The question I had is how could I have such turbulent emotional swings over such an insignificant sum? Clearly, the monetary loss was not the issue. The real issue was Confidence. I’m a decent poker player and comfortable at the table. I’m confident that I’m good enough to win over the long run at the stakes I play. At trading, I had no idea what was happening. The mercurial price movements of the tape were as meaningful to me as the random spins of a roulette wheel.
This was my first insight: I needed a model of market price movement that would give me the confidence to know what the market was doing. It was obvious that the grab-bag of half-understood indicators and chart patterns that I was misusing at the time was not something that made any rational sense. Why should the market move up just because the blue squiggly line crossed above the red squiggly line? Why should the market stop going down at a 61.8% retracement? The Fibonacci number set might well be a good approximation of growth in the rabbit population, but it occurred to me that the habits of copulating bunnies might not be a great predictor of the price of oil.
The market model that I finally discovered was Market Profile or, more accurately, its foundational axioms in Auction Market Theory. Auction Market Theory was, and still is, the only reality-based market model that I understand and believe to be a true basis for understanding price movement. A good market model (or even a bad one for that matter) provides structure, allowing you to identify different market phases and the transitions among them. You can categorize the market at any point in time into a manageable number of states: uptrend, downtrend, balance, break out of balance, etc. In short, you can impose order from the chaos, reducing the infinite number of historical price configurations to a finite set of usable states.
This was my second insight from the comparison of poker to trading. The biggest difference is that poker has a set structure, while trading is formless. A poker hand has a defined life cycle. The hand begins with two cards dealt and has a maximum of four betting rounds. At each decision point, your set of possible actions is constrained: bet or check; call, raise, or fold. Trading has no set structure. You decide when the trade begins. You must also decide when it ends. In between, there is an infinite continuum of possible decision points. It is entirely up to you to voluntarily constrain your actions, to reduce your degrees of freedom, to decide when decision points occur. Without a model of the market, you have no basis to impose a structure on your actions, which is why I was in a constant state of stress during my Damascene trade. I had to decide with every tick whether to continue with the trade or end it. No wonder I was frazzled.
With a trading plan however, trading is much simpler, much less stressful. Have my entry criteria been met? No, then do nothing. Yes, then take the trade. At its simplest, you can place a stop as soon as you enter as well as a profit exit. There are thus no decision points at all during the trade: price either hits your target or stop. No need to make a decision after entry means you don’t have to obsess over every tick, you don’t need to watch it at all.
I know these insights are not at all original. They are only powerful to me because I thought them myself, based on my own torrid experience in the markets. I hope that you find these thoughts useful. I’ll probably do another poker-inspired blog before I sit down for my pre-Vegas ritual of watching Rounders again – it never gets old. Pay that man his money.
Trade well and run good.