Want to be a better trader? Learn how to play poker.

And I don’t mean internet poker. I mean real, honest to goodness, brick and mortar poker, where reading emotion – and controlling emotion – are key aspects of the challenge. (If there are no public poker rooms in your neck of the woods, a well-run home game will do.)

The parallels between trading and poker are uncanny. (Here is a good example.) For yours truly, a love of poker sprang forth from a deeper passion for trading. One literally led to the other.

Seven years ago or so, I had a big client who took me out to lunch once or twice a week. This guy, a sharp entrepreneur and still a good friend, had become obsessed with poker as a hobby. At many of our lunches it was all he could talk about.

After listening for a while, and interjecting / asking questions here and there, I began to think:

“Hmm. Patience… emotional management… a blend of psychology and mathematics… calculated aggression and risk control… this sounds a lot like trading.”

And so I started playing, and it was true – poker really was a lot like trading. I quickly discovered firsthand why so many top hedge fund managers love the game. (David Einhorn, who goes to the World Series every year, cashed for $659,000 in 2006. Then he donated it all to charity. What a guy!)

I also had the encouragement of final tabling the first decent-sized tournament I ever entered – a result I credit to trading experience.

Many years on, the lessons are still flowing. To riff on a Warren Buffett quote, re, investing and business, “My trading makes me a better poker player, and my poker playing makes me a better trader.”

What I’m going to do here, in this multi-part series, is share some “proprietary information” in the form of three acronyms I created that help define my poker game.

These acronyms are the distilled result of many years of playing, thinking about, and analyzing the structure of, the game of No Limit Texas Hold ‘Em. Collectively I call them the RENO process.

I share here, of course, because they naturally have application to markets…

Complexity, Opportunity and Mistakes

An important note: The first area of similarity between poker and trading is the swirling complex of variables. There is just an incredible amount of stuff to pay attention to – too much to keep straight in your conscious mind at first.

I still remember the first time (circa 2004) I walked into a casino poker room. Trying to make sense of the action made my head spin. The speed of cards being dealt, chips being thrown, pots being swept… taking it all in was a monumental task.

Over time, though, the game slows down as your brain soaks up the layers. The movement and the actions all start to make sense. Now I can listen to music, eat a steak sandwich, and even read a stack of market research as I dominate my opponents. (I generally don’t read at the table any more, though I did for a period for years.)

Even when you know the game inside out, tracking the variables is still a critical task.

Not only do you have to do this well, you have to do it in real time with real capital on the line, which makes all the difference in the world. No book or course can help when you have to make dynamic decisions on the fly, in the face of emotional pressure more often than not. Only a buildup of practice and experience does the trick.

Meanwhile, your two primary goals as a poker player are 1) identifying opportunities and 2) avoiding mistakes. The more opportunities you find and exploit, the more the law of averages works in favor of your chip stack. And the more mistakes you avoid – particularly the big ones – the fewer chips you give back.

You would be surprised, by the way, by the sheer amount of mistakes most poker players make. And I don’t mean just beginners or novices either. The fact of the matter is, most players are somewhere between mediocre and terrible… even those with ten or twenty years of seat time in the game!

(Most poker players don’t improve with each passing year — they just have a permanently cyclical experience, repeating the same year over and over again.)

In poker, a mistake can loosely be defined as any subpar action or suboptimal decision that  winds up costing you money in the long run, relative to some better decision you could have made. In poker parlance, a consistent mistake habit is called a “leak.”

The average poker player leaks like a sieve and, worse still, is not really committed to changing this situation. (The good news is, there are steps you can take to correct this.) The higher grade poker player has far fewer leaks, but still suffers from a handful of big ones that show up in recurring situations.

And the best, truly world class poker players have zero leaks… or leaks that show up very, very rarely (about as often as a straight flush).

RENO: Range, Equity, Narrative, Odds

One of the best ways to get rid of leaks – to get sharper at spotting opportunities and more consistent in avoiding mistakes – is to develop a reliable process. By developing a process, I simply mean a standardized checklist of actions you take, and considerations you make, before executing on any decision where the possibility of a mistake is present.

This is where the RENO process comes in.

“Reno,” in addition to being the biggest little city in the world, is the acronym I came up with to cover the four primary areas of consideration at any point of action within a poker hand:

• Range applies to your opponent’s potential range of hands. What could he be holding? A big pair (aces, kings, queens)? Ace-Face? A raggy draw? Determining the range of hands that make sense – and it is indeed a range, as opposed to just “putting a player on a hand” – means assessing player temperament, style and aggression levels (loose or tight), betting patterns, and the history of the hand thus far.

• Equity speaks to the advantages you bring to the hand. For example, if you have “position equity,” your ability to act last in the hand amounts to an informational edge. If you have “hand equity,” it means your holding is strong in the conventional sense (a strong starter hand). “What’s my equity,” i.e. your empirical justification for putting chips at risk, is an important question we’ll discuss further via the second acronym.

• Narrative speaks to the “story” of the hand, and also the story of the session and the table on the whole. This is where you think back to all the action that has occurred, and how it impacts decision making in the present moment. For example, didn’t your opponent just order his third vodka cranberry fifteen minutes ago? And didn’t you see him recently drag down a pot with top pair and an extremely weak kicker? What does that say about his play? Or more specific to the hand, how did the story begin? Was it a limpers’ pot? Who was the raiser? What was the reaction to the scare card on the turn? There are many levels of narrative…

• Odds are where the basic but vital art of mathematical calculation comes into play. You have an Ace-high flush draw after the flop. Should you call your opponent’s continuation bet? It depends on the odds – the size of the bet, the size of the pot, potential for gain on future streets, and so on. Poker math is basic – it never gets all that complicated – but the application is creative and constant. In addition to wasting chips on dumb bets, many passive players waste opportunities where the situation demands a  bet, simply on a pure odds basis. Most poker players have a superficial understanding of odds, but a very poor practical understanding as to how those odds apply. (This is a good thing!)

We’ve barely scratched the surface here, and the lessons run very deep. But hopefully you’ve gotten the idea thus far.

Now how do we apply this to trading?

Well, if you think about it, each of the four RENO components – Range, Equity, Narrative, Odds – has  parallel application when it comes to the discretionary decision-making process of putting on a trade.

“Range” equates to the range of possibilities, or market scenarios, that can be considered for the trade. Just as it’s a popular yet bad idea to put a player on a single hand – except in rare situations where only one holding makes sense – it’s a bad idea to assume only one outcome for a potential trade or investment.

Thinking through the “range” allows you to be mentally prepared for the different scenarios that might unfold, applying reasonable probability percentages to each. You want to be cognizant of what could go wrong and why — and also what could go right and why — not just to minimize risk but to maximize opportunity when the time is right.

This is even more important in a whole portfolio context, i..e applying to not just one trade at a time but your broad market exposure on the whole.

“Equity” refers to your accumulated edges, or empirically confirmed advantages, that justify taking a trade. We’ll look closer at poker equity with the second acronym. For now, let it suffice to say that “What’s my equity?” is another way of asking “What are my justifications for being in this trade?”

For example: In poker, having position on your opponent – acting last – counts as an advantage, and often a decisive one. There are any number of “marginal” type hands where playing from position makes sense, for varying reasons, whereas playing the hand from out of position does not. In markets, the equivalent of having position could be represented by an excellent chart pattern, or buying at a sharp discount to net asset value, or some such thing.

Without getting too specific, there are multiple types of empirically justified advantage. The more of them you can  accumulate the better, and the more of them you have the greater your “equity” in the trade.

“Narrative” speaks to the “story” of the trade, or the market script. When it comes to actual poker play, there is no such thing as a decision out of context. There is always the history of the session, the history of the opponent (or opponents plural), and of course the preceding actions and cards displayed in the hand thus far.

Markets are the same way: What will happen tomorrow is significantly impacted by the events that have unfolded yesterday and today. A good discretionary trader is constantly assessing and re-assessing the narratives and themes impacting markets at any given time.

“Odds” speaks to probability of success and the risk/reward profile of the trade. Traders in general have an infatuation with high probability trades. Sometimes, though, lower probability trades can be more lucrative. Why? Because of the risk / reward profile.

For example: Imagine a high optionality trade with only a 1 in 4 (25%) chance of success, but clearly defined downside and the opportunity for an 8 to 1 return (800%) on capital at risk.

If you could confirm the payout odds as  realistic, you’d be crazy not to make that trade repeatedly — the ROI is excellent.

This profile, in fact, roughly approximates the venture capital model, where most seed investments don’t work out, but the winners overpower the losers with major outsized returns. It also captures the spirit of odds-based decision making when the probability of success on any individual bet is less than 50/50, but the collective host of bets is profitable — a poker phenomena that recurs over and over again.

Point here being not to over-emphasize the virtue of low probablity / high payoff trades, but instead to highlight the value of considering and re-considering realistic odds combinations – in terms of both risk/reward profile and probability of success – for both individual trades and portfolio exposures in aggregate.

We’ll look at the other two poker acronyms – and their cross-application to trading – in Part II and Part III.

JS

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