By Guest Writer – Trader1 (CMR Member)

Scenario

You’re sitting at a table in your favorite poker room. Around you are the usual cast of characters: the out-of-work actor, the “restaurant owner,” the sports writer for the Post, the guy whose dad has a real estate portfolio measured in Bs instead of Ms. Sanitation Dave recently retired from picking up garbage and has a fat pension from the city.

Everyone has their poker name, and in the poker room, that is their name. You may have known “Tony the Actor” for five years before you find out his real name is Joe.

The game is $10/$20 No-Limit Hold’em, a cash game. You’re on the button, the symbolic representation of the dealer. This is the best position at the table because you get to act last and therefore have more information, which should translate into better decisions.

Tony the Actor (Joe?) is first to act, or under the gun. He looks at his cards and raises to $100.

NYU Chuck calls from middle position.

Mountain Man is sitting to your right in the cutoff. He calls as well.

Both Tony the Actor and Mountain Man are decent players. NYU Chuck is rich and looking for a good time.

You take a peek at your cards and see an Ace and 8 both hearts. You decide to call. Both blinds fold.

There is now $430 in the pot.

The flop comes:

4♥ T♥ J♠

Tony the Actor slightly shrugs and fires $150 into the pot.
NYU instantly calls, he’s bored.
Mountain Man calls.

The action is on you. What do you do?

There is now $880 in the pot.

You put Tony the Actor on AA, KK, QQ, JJ, TT, or perhaps KQ (possibly hearts).

NYU could have anything from 2-3 offsuit and up.

Mountain Man is likely on a draw maybe 8-9, KQ, something like that. Anything stronger and he probably wouldn’t have kept the turn decision cheap for me. At the same time, he likely realizes that semi-bluffing his draw isn’t going to work very often with Tony likely strong and NYU calling anything like his life depends on it.

But none of this really matters for the immediate decision.

Let’s rule out a semi-bluff for similar reasons as Mountain Man. It might be worth considering in a tournament when you’re short-stacked and close to the money, but in most cases there is a very simple and straightforward decision.

You call.

Why do you call?

With $880 in the pot and $150 to call, you’re getting almost 6-to-1 on your money.

Your chance of hitting another heart on the turn and making your flush is roughly 4-to-1 against.

This means that if you are in this scenario 1,000 times, on average you’re going to win around 20% of the time.

For simplicity, we will ignore the additional money that could be made on the river as well as the possibility of making your hand on the turn and losing to a full house or better on the river.

For 1,000 hands:

You win 200 times

(880+150)×200=$206,000

You lose 800 times

150×800=$120,000

The call therefore has positive Expected Value and a reasonable Standard Deviation.

This was the lens through which all of my decisions were made at the poker table.

Trading didn’t really click for me until I started thinking about it the same way.

But it didn’t end there. Other similarities kept revealing themselves.

Table Selection, Market Selection, & Why Liquidity Matters

Whenever I entered a poker room, I would walk around and look at the different games being offered and the different limits. More importantly, I would observe the tables.

Which tables are having fun?
Which tables look like they just left a funeral?

Do I have enough bankroll to play in the “best” game I find? Is the vol of that game going to make it effectively play much higher? Do I want that level of variance in my results right now?

I would then speak with the floor and request to get on specific lists and mention which tables I preferred. I would take whatever seat became available, but the floor staff looked after me and would move me where I wanted to be once they had the opportunity.

Ideally, you want a table with a lot of action, big pots, several players involved in most hands, more calling than raising, unless it’s from you (lower vol).

This isn’t always possible, but it’s what you want.

Think of it as having exit liquidity for your big hands. You need someone on the other side of the transaction willing to take the action. That is the type of table where I can maximize my edge. If I have a good hand I want to be playing with the drunk partiers at 11pm on a Saturday not the retirees looking to pass the time at 8am on a Tuesday.

I think about this concept in the markets primarily through liquidity and market hours.

If you want to exit your position at the best price, you want that price to be somewhere close to where the last transaction printed.

I learned this the hard way late last year in the aluminum futures market. I had an order in the market to get out, and I did get out, but nowhere near the price I expected.

Needless to say, market selection and ample liquidity are now hard requirements.

Hand Selection & Market Setup

If I had played every hand, I would have gone broke.

One of the first things you learn in poker is relative hand strength based on position. The later you are to act, the wider range of hands you can play profitably.

Much like in trading, if you trade every market or take every trade you think you see, you’re probably going to go broke.

There are times when you should be selective and only trade your “premium hands.”

Other times the market environment is more forgiving, and you can play a little looser while still being profitable.

The Importance of Acting Last & The Closing Price

As discussed earlier, the most advantageous position at the poker table is when you get to act last.

Why?

Because all the moves are already in. You get to make your decision after seeing what everyone else has done.

That information is valuable and allows you to enter more marginal situations that would not be profitable if you had to act earlier with more decisions coming behind you.

I think of the market’s closing price in a similar way.

Everyone’s moves for the day are in. There are no more intraday shakeouts, fakeouts, or whatever you want to call them.

Trading based on the closing price is like playing a poker hand from the button.

Going on Tilt

This one seems unavoidable whenever money is involved.

You see it all the time at the poker table. A good player who plays beautifully when things are going well takes a few bad beats and suddenly starts playing like a wild man, destroying his edge and giving back hard-earned profits.

Same story in trading.

The terms may differ: revenge trading, overtrading, chasing — but the phenomenon is the same.

Emotions have taken control.

Risk Management

I have played with some tremendously talented players — players with far more natural talent than myself.

I mostly learned through books, observation, and hours at the table.

These guys were naturals.

And they made excellent decisions 90% of the time, sometimes bordering on brilliance.

The problem was the other 10%.

Those decisions often busted them out.

Usually this happened because they were playing over their heads, sitting in the biggest games available without the bankroll required to withstand the variance of the higher stakes.

This was also a quick recipe for going on tilt.

The result was gigantic runs upward followed by speed runs back to zero.

I went broke a few times playing poker as well, but that was early on when I lacked any concept of bankroll management.

Once I figured that out, I might have been playing at the kids’ table while my friends sat with hundreds of thousands of dollars in front of them, but I was also the one they came to borrow money from after they busted.

I was playing within the limits my bankroll allowed and prioritizing long-term survival.

In trading, I think of this as position sizing and how much I am willing to risk on any one trade. I want to live to trade another day.

Conclusion

There are many more parallels, but ultimately poker taught me to think in terms of probabilities and to manage risk over the long term.

Approaching trading by drawing parallels to concepts I have internalized in prior speculated related activities has proven to be tremendously helpful at keeping me focused on what really matters.

Poker taught me that good decisions can lose money and bad decisions can make money. That is after all what keeps everyone coming back for more.

Trading works the same way.

Over small sample sizes, outcomes are noisy. Over large sample sizes, your edge and staying disciplined to your process is what matters.

Think in terms of sample sets. Detach your emotions and ego from the outcome. Whether you are right or wrong about a trade thesis means nothing. What matters is that you’re building or following a process that shows a positive expected value over an appropriate time horizon.

As everyone’s favorite Market Wizard always says, be wrong, make money!