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Transitioning From Online Poker To Trading Financial Markets

|Includes: AGG, SPDR S&P 500 Trust ETF (SPY), TLT

A frequent question asked by online poker players is:

"Should I transition from online poker to trading financial markets?"

Ever since Black Friday in 2011 a lot of poker players had to reconsider that their plans for being a professional online poker player for the rest of their lives. I was affected by that event was much as the anyone else, even though I'm not an US player and in theory should not have been hit by it. Online poker games, which were already becoming tougher every year, became even harder as a result of the removal of recreational US players from the global pool of players. Not only that but a few poker sites decreased their reward systems not long after that which reduced the effective rakeback that players were receiving.

When I looked at this situation I became convinced that I had to move away from professional online poker as I could see no end to these trends, in fact, it was likely to only get worse. I decided I was going to explore more the idea of becoming a daytrader. The reason for that was because I had been investing and trading some of my savings for a few years so it felt like a natural transition for me. I would keep the freedom that poker gave me and still potentially be able to earn a living from my home. Unfortunately, even though my attempts at trading and investing had been successful, very short-term trading (such as daytrading) were not. I would go through periods of small profitability followed by unprofitability. The net result were losses due of trading costs.

Most of the daytrading literature that I had read was very out of date. They would talk about strategies to become "SOES bandits" and other market structure elements that no longer existed for a decade. In order to deal with that I decided that I was going to go in a journey to learn how to daytrade by talking and interviewing the best day and swing traders that I could find. I had always been a fan of interview books where traders would explain key elements of their success. I learned a lot from the Market Wizard's series from Jack Schwager. As a result I decided to do an interview book where the focus would be on how to trade and adapt to modern markets that are dominated by HFTs as opposed to the markets from the early 2000's which were dominated by market makers.

Through the interviews, I ended up learning a great deal, not only on what to do but also what not do to. As I made the transition from poker to trading, I ended up noticing a lot of similarities but also a number of differences that one must be aware in order to make such transition.

Eventually, I was able to make that transition. I wish I had made such change a lot earlier though. I found that day trading stocks was a lot more profitable and less stressful. Some reasons behind that might be particular to me (as I will explain bellow) but some, might be true for a lot of people.

In terms of similarities and differences, here is a list of things I have noticed over the last 3 years as a full-time daytrader


· Mathematical thinking and being aware of when you have the best of it. Its quite beneficial to have a background in poker, specially if went down the Sklansky "math" route as opposed to the instinct based ones. A lot of traders fail because they just chase the lastest momentum stock that is trending on twitter, they have little or no awareness of probabilities, expected value, bankroll management, etc. Being aware of these concepts in trading is crucial. Bankroll management for instance is something that is extremely important in trading. Overbetting one's capital is as harmful in poker as it is in trading. The high failure rate of daytraders have a lot of to do with poor position sizing, undercapitalization and inability to protect trading capital.

· Discipline. The discipline to stop when playing poorly is just as needed in trading as it is in poker. If you are used to quitting a session when you are playing poorly, you will notice that need in trading just as much. In trading a lot of decisions are discretionary, if you are losing money your judgment tends to be impaired. Until your head clears, your decision making suffers a great deal. Quitting a trading day or taking a break are key components of good trading. In fact, discipline in general is something that good poker players tend to develop and that skill carries over to trading. A good poker player will laydown a good hand when his analysis tells him it's the right play, he will also go all-in with a poor hand when he believes it will provide him a long-term profit higher than the alternatives. He might also fold for quite a while if the right situation doesn't arise for him to play a hand. Having the discipline to execute those moves even if you don't feel like is something that is quite useful as market operator.

· Having a good memory and remembering different situations is also useful. In poker as well as trading, similar situations can arise every once and a while. Good poker players can remember a lot of past hands, different lines and strategies. With that information, the player can extract an edge of those situations more optimally. Most of the successful traders I interviewed have a mental database of different trading setups they have seen several times in their careers. As a result of that, they know what to expect of out of a stock and how to play those setups.

Now with the differences:

· Markets are a "continuous process" while gambling is a "discreet event". Lets say you buy a position in a stock and you start to lose money. If you lack the discipline to exit the position after the stock reaches your exit point, you can lose for a long-time. Potentially, you can lose all of your risk capital, sometimes even more, if you use margin leverage. In gambling it's different. If you bet a lot in a poker hand when you know you shouldn't, if you lose, you lose what you bet, or in the worst-case, your entire buy-in. Given that most players only sit down at the table with a fraction of their bankroll (or they enter a tournament with a fraction of their bankroll), risk management is made a lot easier. The decision to take a fraction of their bankroll to the table, is made at home, when the player is well rested and likely not suffering from emotional issues. In trading, if you are losing money and don't do anything about it, you could lose it all. Risk management is more complicated (see bellow) and requires more discipline.

· Gambling can have precise probabilities, while markets require estimates that are prone to failure. In poker you know exactly what is the % chance to win with a hand and a result, know exactly what is your edge. In trading, a lot of the time you are relying in estimates resulting from past experience or analysis. As a result, they are prone to be incorrect, sometimes extremely incorrect. Consequently, managing your risk becomes extremely important. If as a result of poor estimates you occasionally have a gigantic loss, that might be all it takes for you to lose your entire trading capital. In gambling you can rely on tools like the Kelly Criterion to determine bet size, in poker, you can use formulas to determine bankroll requirements. In trading, the application of precise mathematics is no longer reliable. This is because the real world (as opposed to the world of games) is full of surprises. What economists call "fat tails" or "black swans". Highly improbable events that have enormous consequences, to the world and to asset prices. These issues apply even more depending on your style of trading. Example: if you are a short-seller, a fat tail can deliver you a gigantic loss (see the stock KBIO late last year). If you sell OTM options for the leverage they can provide, that also can deliver you a huge loss. If you keep adding to losing positions because your ego gets involved in your trading, you will also face a huge loss at some point.

· Trading can be less stressful than poker for some people. For me, personally, I find it less stressful. It is still stressful but there is something about losing money to another person (as opposed to a stock symbol or futures contract) that requires more emotional control, especially if that player lacks etiquette. For most players, the experience of being "run over" by another player might be all that it takes for them to get irritated. If that player puts a bad beat then the problem is compounded. In trading, you are simply losing to a market not to a loud obnoxious player.

· You might be able to put more hours as a trader than a poker player. For me, having to grind a lot of hours in online poker was very difficult. After one hour of play I would be mentally tired and looking for reasons to quit. That was because in poker, you are constantly required to make decisions. Raise pf, call, cold-call, fold, shove, check player stats, choose bet amounts, etc. In trading, you can go through several hours and not put on a trade. You are just observing and waiting for a situation that you have seen in the past to jump in and risk your trading capital. For that reason, at least for me, I find it less mentally taxing than online poker. I can trade the whole trading day (6.5 hours for the US stock market session) without much problem. In online poker, even pros have a tough time playing 6.5 hours a day. Another difference in the work hours is that in markets, you can to rest on weekends without feeling that you are missing profits. When markets are closed (such as on weekends or holidays) there is nothing to be done, whereas in online poker, you can always think "maybe I should be playing and making money now".

· In my experience, Poker players tend to have bigger egos than traders. I believe that is because they can get away with it. Because risk management in poker is a lot easier (and in some cases, automatic), having a big ego will not hurt you that much. It might even help in some instances if it induces the player to play the optimal strategy (like an aggressive style in short-handed NL hold'em), especially if that ego is not excessive. In trading, however, the punishment for having an ego is greater and whatever benefit one could get (such as betting more when the trader believes he has the best of it) is more than offset by the issues that arise from having an ego. What are these issues? Because markets are a continuous process, it requires constant ACTION to protect trading capital. If you don't stick with loss limits, stops and position sizing guidelines, at some point you will face a large drawdown. When faced with that drawdown, the tendency for a trader with an ego is try to make their money back to prove to himself or herself that he or she is a good trader. The trader might never exit the trade in the hopes it comes back. Because of black swans/fat tails, at some point in their trading career, those traders will face something that never comes back. That is the "career ending" trade that a lot of traders fall for. In poker, you would need to constantly be adding money to the table or getting into more and more tournaments to blow up, that requires constant action. In trading, all you need is inaction. As a result of these differences, traders with egos disappear quite quickly. But in poker, you could survive for quite a while (maybe even in the long-term) despite some psychological flaws.

So, should you make the transition from poker to becoming an active short-term trader? Only you can make that assessment. You have to be aware that while there are similarities, there are some key differences as well. Depending on what kind of player your are (your strengths and weaknesses) that transition can be successful or it can be disastrous. For people who gambling urges and an ego, poker is the right environment for them, trading won't fit their personalities very well. They need the protection of discreet events to limit the exposure of their risk capital to their own flaws. For disciplined math players that can leave their egos at the door, trading can be an interesting career choice.

Fernando Oliveira is a full-time trader who is the author of the book "Traders of the New Era Expanded Edition: Interviews with a Select Group of Day and Swing Traders Who are Still Beating the Markets in the Era of High Frequency Trading and Flash Crashes"