APPLYING POKER THEORY TO SPECULATION IN THE FINANCIAL MARKETS
Just to give a little background, after I closed down my hedge fund, I really didn't know which way to go. I knew I didn't want to go back to Wall Street type job. Those few Wall Street jobs that I would have considered, I didn't have the pedigree for.
I had played poker in the past fairly regularly. I had studied it and been profitable playing. I had never considered playing poker for a job or to make a living. I gave it a shot, however. And for a period of some months, my only income came from the poker tables. It got tiresome very quickly, and I decided to start a company completely outside of the financial markets following my poker adventure. Nevertheless, over the years that I have been playing, I have learned that having a poker mindset is advantageous in the financial markets.
I approach the financial markets with the same odds and probability mindset that I used in poker. It is a similar game, the financial markets, in that you are using imperfect information to make judgments about the future actions or intentions of your opponent. In poker, it is best to attempt to assign a range of hands to your opponent based on their actions as each card comes out and in reaction to your aggressiveness or passiveness. In the markets, you attempt to gauge the markets intentions by gauging the prevailing psychology and attempting to understand the deception that the market routinely tries to sell its participants. In both cases, you are reacting to an imperfect set of data that you must decipher in order to correctly assess your opponents true intentions.
I also use the same method of "table selection" or "game selection" that I did in poker. But instead of a table or game to sit at, in the financial markets you pick a sector or market cap that you are comfortable investing in. Table selection refers to choosing tables that are littered with "fish", "donkeys" or "suckers", if you prefer. Game selection refers to picking a game where you have the greatest edge. The general theory of poker states that the better you are, the more hands you want to play with opponents who do not have your skill-set. Therefore, it is best to select games with perhaps 5 opponents, as opposed to 8. Or, if you are THAT good, choose a game with 3 opponents, instead of 5. And the best of the best, choose to play 1 on 1, as this is where they are able to demonstrate and profit from their edges the most.
I have clearly applied table selection and game selection in poker to the financial markets. It took me a very long time to discover the fact that I wasn't choosing the game or sitting at the table in the financial markets that was the greatest benefit to me as a speculator. The very reason that I exclusively trade micro-cap names is based on what I learned with table and game selection in poker. Allow me to explain.
Each day that I wake up and sit down to trade the markets, I have a choice of literally tens of thousands of instruments to trade. These are equivalent to the tables and games I can choose to sit at in a casino or online. For example, if I choose to trade large cap stocks for a living I know that my opponents are:
1. Very large institutions..pensions..mutual funds etc.
2. All sizes of hedge funds.
3. High frequency trading shops that hop around these stocks like fleas on Mexican alley cat.
In poker terms, this is the equivalent of a table filled with sharks, grinders, professionals. Yeah, I may be able to grind out a profit. But it will be just that...a grind. I will be exploiting small edges all day and end up bringing home pennies. Not to mention the fact, that it takes a toll on you mentally and the potential for burnout is great.
The same opponents will be running wild in S&P/nasdaq futures, popular currency pairs, etfs. These are all the equivalent of tables filled with sharks.
I'm not in the markets to prove anything to myself or to my opponents. I am here to profit and remain in peace...not in pieces.
Now let's look at the opponents that I face at the micro-cap table:
1. Small investors
2. Small mutual funds/hedge funds
That's it. Nowadays, it has become especially thin as the small investor prefers to keep his money under his mattress. So you essentially have a table full of fish and maybe one or two sharks.
How do I exploit my edge even further? I throw the specter of reorganizations, a spinoff, bankruptcy, debt restructuring into the mix. This causes my table that was filled with 2 sharks and 5 fish to dwindle down to a table where it's me and one fish heads up...a professional poker players dream. You can go on busting the guy out all night because of the various edges you have over him.
The reorganization process throws everyone for a loop. It causes individual investors that stick around to completely misjudge and misunderstand the situation. It causes institutions that aren't activist or special situation type investors to liquidate. It leaves only a few guys sitting around throwing chips at you. This is where the massive inefficiency in the market lies. This is where the money is made. This is how you sit at a table and bust a dude out all night, before he goes home with red eyes and rabbit ears.
Look...I know a lot of you have something to prove. You're into ego before profit...that's fine. As a wise man once said, "everyone gets what they want out of the markets". If you are out to prove something, go ahead and take a seat at the table with all the sharks...you may get lucky. I, on the other hand, prefer to rely on my skill. And I want that skill to be as effective and pronounced as possible. Why would I attempt to match wits with investors who I can only exploit small edges over? I'm of the mind that sitting at a table with an investor who I can exploit to my maximum capability is my best chance for profit and success.
