By Van K. Tharp, Ph.D. - Van Tharp Institute
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I’m currently reading Why You Lose at Poker by Russell Fox and Scott Harker. I’ve pretty much promised myself that I won’t play poker for real money again until I’ve read at least three poker books and come up with some major paradigm shifts. As I read this book, I’ve been struck by the amazing similarities between poker losses and trading losses. They are similar sorts of mistakes. As a result, I thought I’d write a series of articles covering various chapters in Why You Lose at Poker and relate them to trading mistakes that I’ve seen.
Part I: Playing Too Many Hands or Not Waiting for the Opportunities that Are Likely to Make Money
When I first started playing Texas Hold ‘em Poker, I had a friend run a computer simulation to determine the chance of winning for all 169 starting hands if you and every other player stayed in through all five up cards. We did ten million simulations with 2 players, 4 players, 6 players, 8 players, and 10 players. I’d seen someone list the probability of winning with each hand, but I didn’t believe that. It turns out I was right not to believe them after we looked at the results of our simulation.
Here were a few of our conclusions:
The top starting hand was AA. It gave you an 87% chance of winning when there were only two players, but only a 33% chance of winning with ten players. This is why poker experts recommend betting big when you have a high pair to get as many people out as you can.
When you got down to the 20th best starting hand, which is A9 of the same suit, you have a 62.6% chance of winning heads up (i.e., against one other person). But you only have a 15.74% chance of winning against ten players.
At the 50th best hand (44), you only have a 57.4% chance of winning heads up and a 12.74% chance of winning with ten players staying. Notice that with the 50th best hand the odds are 5.7% in your favor with two players and 2.74% in your favor with ten. Those are not outstanding odds, but they are equivalent to some of the best odds that you might get with a good entry signal in trading.
By the time you get to the 94th best hand, you have a 10.07% chance of winning with ten players (i.e., the odds are 0.07% in your favor) and only a 49.25% chance of winning heads up (i.e., the odds are 0.75% against you). However, the 94th best hand is different for ten players (i.e., A4 off-suit) versus two (i.e., T8 off-suit). Heads up A4 off-suit is the 49th best hand, so having an ace plus junk in your hand is useless with ten players and slightly advantageous with two players.
Clearly knowing the winning odds of the cards in your hand can help you play better. The same is true with the signals you from your trading systems. But have you taken the time to learn the odds?
Do you know the probability of winning with the trades you take? Do they differ depending on the market conditions? There are various types of markets, so the probability of winning with certain signals probably changes dramatically in different market types. Have you done the necessary research (as I did with poker hands) to determine the chances of winning with certain signals?
If you haven’t done this sort of research, then you are probably making a mistake. For example, what if you find a Graham’s number stock selling at 0.6 times its liquidation value? Is that a good deal? Or what if you find a stock that meets all of William O’Neil’s CANSLIM criteria? Is that a good deal? What are your chances of making money with those stocks?
In addition, as a poker game progresses, context becomes important. Let’s say you have KK, the second best starting hand. You bet 5 times the big blind and only one person calls. You now have odds you like, only two people playing, and you have the second best hand. The person who called you might have another high pair or perhaps a hand like AQ suited. Now comes the first three cards or the flop and those are AQJ. Now how does your KK look? Not so good. If you opponent has one A, you are in trouble. You are in even worse trouble if they called you with QQ or JJ. You bet half the pot and they re-raise you. Staying in the game under such circumstances is probably not wise and it’s another example of playing too many hands. But again, it is context dependent… perhaps you opponent is someone who calls most hands to see the flop and someone who bluffs a lot. If so, that might make your hand appear stronger.
Trading is also a context dependent activity. You enter into a position and the next day favorable news comes out but the stock reacts poorly. You enter another position that goes up while 90% of the market goes down. What do you do with the positions now? These are context dependent decisions. Have you done enough homework to understand how to respond? If not, then like the unprepared poker player, you are making a big mistake.
Chances are most trades are just like starting poker hands: good ones give you just a slight edge. What’s important is your win/loss ratio. It’s fine to make money 40% of the time if your winners make 2R and your losers only give up 1R. Playing too many hands of poker could be the simple equivalent of making too many trades when the risk/reward ratio is not favorable enough for you to make consistent profits over time. We’ll discuss that much more extensively in Poker and Trading Mistakes
About Dr. Van Tharp: Trading coach, and author, Dr. Van K. Tharp is widely recognized for his best-selling books and his outstanding Peak Performance Home Study program - a highly regarded classic that is suitable for all levels of traders and investors. You can learn more about Dr. Van Tharp the Van Tharp Institute.