Of Poker and Balance Sheets

October 12, 2012
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It’s always fun to check out a new poker room — especially when reputed to be the best poker room in Las Vegas.

We have dragged pots in all the well known rooms (Venetian, Wynn, Bellagio etc) on multiple occasions. Next week, though, we will play at Aria for the first time, and stay in the Aria hotel. We will also check out the real estate values at City Center — a future Mercenary satellite headquarters? We shall see…

For those of you coming to the Alternative Asset Summit, be sure to touch base. If we don’t see you at Aria, maybe we’ll catch up at the Wynn.

In reference to “How to Win an $800 Pot With $5 Worth of Risk,” skeptical reader Brad P. writes:

So essentially you got lucky by all the cards coming up on the table. Maybe some guy should write an article about how he won the lottery with $5 of risk….

Your story is 70% luck, if not 80%.

He doesn’t know us very well, does he?

Brad — we humbly suggest you take a better look. If the depth of one’s gaze runs two inches deep, perception will always be shallow.

Obviously riskless ~80R opportunities don’t come along every day… but there were multiple points to the anecdote…

The first point is that excellent situations do in fact exist where one can reap substantial reward for very little risk. This is true for markets as well as poker, and flies in the face of academic theory (which ridiculously states that reward is always proportional to risk).

In further respect to the above, the hard part is not just making the money, but keeping it. As the old saying goes, bad traders never make profits — they only take out short-term loans from the market. (So too with poker players.)

What’s more, in order to be physically present — and properly capitalized — for the situations that offer stellar reward-to-risk, you have to be sitting at the table in the first place.

This requires consistency (in showing up day after day); creative awareness (to spot opportunity and know it when you see it); and risk management skills (to navigate a steady stream of more complex situations — some of them quite tricky — without losing your chips).

Every so often you hear stories of the great trader who saw a “no brainer” type situation, made a very large bet (with virtually no risk), and reaped profits in the millions (or tens or hundreds of millions).

So easy! Like falling off a log.

But what one does not hear about is the consistent vigilance, the relentless due diligence, and the high quality risk management application to countless unavoidable instances of less black-and-white decision making that allowed for such positioning, dry powder fully intact, in the first place…

In other words: To take the great trades (or poker hands) that show up a few times per year, or even a few times per decade, one cannot simply hit the beach or call in from the ski chalet. Year-round involvement (most likely day-to-day), and survival skill plus diverse money-making ability applied across the full range of market conditions, is the hidden prerequisite.

(Coincidentally, this is why we rarely if ever take vacations from the Mercenary Live Feed… and when one partner takes some once-in-a-blue-moon R&R for the sake of battery recharge, the other still watches…)

The second point of the story was that, in a zero or minus sum game, risk management mistakes create opportunity… sometimes huge opportunity. It thus becomes imperative to be the skilled exploiter of such mistakes, and not the mistake-maker being exploited.

We’ll go into more detail in the follow-up piece…

Also regarding the $800 pot, our friend Arpad in the UK writes:

Great story.

Believe it or not, I had virtually the same situation, but it was at a £1,2 table at the Vic in London. Ended up being an all in, after he bet double pot, and I tripled his bet. He was quite disgusted. I remember the losing pots vividly,

But that one winner definitely stuck out as a scenario that was tough to improve on(ex the higher table stakes).

From the movie Rounders:

In Confessions of a Winning Poker Player, Jack King said, “Few players recall big pots they have won, strange as it seems, but every player can remember with remarkable accuracy the outstanding tough beats of his career.”

We find this to be true, but with a caveat. For the creative thinker and dedicated analyst — the type of individual who consistently revisits a session history, looking for nuances, subtleties, alternative lines of play, and possible insights as to how play could have been improved — it is the interesting or unconventional hands that stick in the memory, regardless of whether the result was profit or loss.

The primary somatic marker, at least for us, is thus the wattage of the  “a-ha!” or “Hmm” light bulb clicking on, rather than the ups or downs of pots won or lost… major tourney cashes notwithstanding!

Speaking of table stakes, this is another area where risk control creates opportunity in both poker and markets… at the No Limit table, many players either fear the higher stakes or fear sitting down with appropriately large stacks.

Why fear playing a large stack?

In part due to the swings, but also in part due to tacitly acknowledged lack of discipline and control. Many a player at the 2-5 and even 5-10 No Limit levels will only put $500 to $1,000 at a time on the table, but not more, for fear they might mess up and lose it.

A common exception to the above is the aggressive ‘maniac’ or ELA (extreme loose aggressive) player, who is willing to play larger, but only via brash fearlessness and a kamikaze-like attitude to losing very large amounts. This is a substitution of “boldness” and “money to burn” for skill and common sense. (Coincidentally, we love these guys!)

Both strategies are suboptimal. Limiting one’s capital in play out of fear reduces capacity to exploit opportunity… because you simultaneously have fewer chips with which to bet when excellent opportunity presents itself, and lesser resources to defend strong hands. And of course, losing money brashly, as the maniac / ELA always does given world enough and time, is a recipe for expensive entertainment, not winning.

For the above reasons, when you see a poker player with a very large stack at an uncapped buy-in table, much of the time you can assume this player is wealthy (or foolish, or both) and unconcerned with chip risk.

If said player demonstrates potentially exceptional levels of skill, creativity, and control, however, then watch out… because the deeply capitalized and deeply knowledgeable player is both very rare (relative to the other more common types) and very dangerous.

And of course, to play a large stack calmly, confidently and creatively, for maximum EV (expected value) over the full span of decisions over time, one needs ‘conscious competence’ and an ability to perform under pressure… the same qualities required to pull meaningful sums out of markets (via skillful deployment of meaningful amounts).

If you have no affinity for poker, we apologize. Blame it on the upcoming Vegas trip… but also on a deep and abiding appreciation for poker’s relationship to trading…

As Jeff Yass, the founder of options-trading powerhouse Susquehanna, put it in New Market Wizards:

…the poker world is so competitive that if you don’t fully capitalize on every advantage, you’re not going to survive. I absolutely understood that concept by the time I got down to the options floor. I learned more about options trading strategy by playing poker than I did in all my college economics courses combined. 

For more on the way poker has helped a trader make millions (billions?), read this excellent profile piece on Yass and Susquehanna.

Switching topics (to the relief of many we imagine)… in response to “Hey Bill Gross, Why So Serious?reader Hasan writes:

Jack,

I think your points are soon to be outdated. The US dollar is losing its reserve currency as china has anounced trade and currency deals with many other countries. This has rendered the USD surplus to require,eats around the world in the next few years bringing massive inflation. Also your point that China and others are a major creditor of the US is no longer true since china has stopped buying US debt and it is only the fed that that is buying every worthless TBond available through QE infinity, OT etc creating the biggest TBond bubble ever. This leads to massive currency debasemant which incentivises nations who hold dollars to dump them causing hyperinflation in the US as the all the dumped dollars will float back there. Once the bond bubble bursts and the Fed can’t get away with printing more money then game is up. Bankruptcy. One cannot be a military super power without money and one cannot be so important to the world if their reserve currency status no longer exists. To suggest that the US is too big to fail is misinformed. Economically if the US fails it would cause major deleveraging of the $1 quadrillion dollars of derivatives debt in the world and will later restart world economic growth as the chinese rnb backed by gold or even a basket of currencies would restart trade and free markets soon will exist by demand from emerging economies such as the BRICS. I could go on but It’s worth reading this article from Dr Paul Craig Roberts who I’m sure you know of. He explains it pretty well.

http://www.paulcraigroberts.org/2012/06/05/collapse-at-hand/

Hasan

And to which yours truly replied via comments,

Hi Hasan,

Here is a stream of consciousness (read: 100% off-the-cuff) reply that came out a little lengthier than expected…

Different viewpoints are certainly welcome, and it takes all kinds to make a market. With that said, there is a certain “stopped clock” aspect to those who have been declaring the United States to be like the Roman Empire in its last days and predicting the imminent demise of the dollar as the world’s reserve currency. This thesis — that America is doomed — has essentially been in stasis for a decade or more. The thesis that Japan is going to collapse under its own fiscal weight has been around for even longer.

Simple empirical evidence demands a rethink of aggressive assumptions that have failed to come to pass for years and years on end, especially when the drivers behind the argument have given no indication of adjusting or updating. The title of the Paul Craig Roberts article you cited was “Collapse at Hand.” Really? The trouble is such article titles existed seven years ago. Calls for hyperinflation based on a collapse of the US Treasury bond market are also many years old now. Is it possible the timing was off and “at hand” just means waiting a little while longer? Maybe. Or maybe this view of the global economic puzzle is fundamentally misguided and wrong, via the failure to include some very important pieces…

In addition to the above observation — all too many instances of “imminent demise” prediction have proven false — evidence is mounting that the China miracle is a fraud at worst and a fizzling bottle rocket at best. Indeed, there is ample and growing evidence that 1) China is the biggest malinvestment case of all time, as we have argued, and that 2) China is in real danger not just of hard landing, but outright economic implosion. It is hard to see China leaping to the fore of the 21st century when the entire country bears resemblance to a growth stock with cooked books that is about to suffer a collapse in confidence and a major restatement of earnings power, even as demographic disaster and the threat of supercycle food, water and energy shortage looms (three areas where the U.S. has a distinct global advantage by the way).

Then add to the above the fact that those who predict the fiscal demise of the United States have never really given proper consideration to the asset side of the U.S. balance sheet. Looking at treasury bonds in a vacuum and saying “it’s the biggest bubble ever” is like looking at the debt on a company’s books without looking at the scope or extent of the company’s assets, especially if a large portion of those assets are being carried at cost i.e. not marked-to-market. The debt-offsetting value of the United States’ military power, agrarian output, intellectual property, institutional memory, political stability, rule of law longevity, demographic vitality, and extensive corporate / household wealth are virtually never discussed in the “America is doomed” presentations, but they all contribute to reasons why U.S. currency (and safe-haven government debt) have proven much more resilient than the doom predictors might think.

To better understand why U.S. assets (and strategically important advantages in food security and increasingly energy security) are so important not to leave out of the equation, consider how a run on treasury bonds (a UST implosion) would have to come about. If there were any attempt to sell off treasury bonds outright, the Federal Reserve would step in and begin buying USTs in unlimited qualities with electronically printed dollars. This in turn would keep bonds propped up, but threaten to collapse the US currency market.

Downward pressure on USTs would cause US interest rates to rise, however, which would in turn jeopardize the entire global economic recovery. Fears of renewed economic meltdown as China and Europe sputter would lead to a recommitment to safe haven assets (like USTs), which in turn would induce buying of the same assets that were previously being sold off.

In addition, given that the dollar would be the weakness transmission mechanism in any bond collapse (as the Fed can always print dollars with which to buy unlimited amounts of bonds), a rapidly weakening dollar would provide an absolutely compelling asset purchase proposition for desirable US assets. When the US dollar declines, it provides the ability to buy US assets at a discount relative to the alternative currency against which the dollar is falling. Thus, were the USD to show signs of collapsing, how quickly do you think overseas investors would begin to salivate at huge currency-induced opportunities in the shares of companies like Apple and Google and Exxon, or the currency-adjusted property values available in U.S. real estate (particularly the major coastal cities)? A flood of opportunistic capital would come in seeking to purchase trillions and trillions worth of discounted US assets, which in turn would put a floor under the sale of the currency. This dynamic works the same as assets on the balance sheet of a public company putting a floor on the falling share price, because at some point those with the ability to value the balance sheet assets cannot resist the bargains being presented.

Finally, in order for $USD denominated assets and treasuries to collapse, someone has to explain the alternative destination, i.e. where many trillions in capital and reserves are going to flow. Into Europe? The European Union is on the verge of disintegration. Into China? The China miracle is in large part a smoke-and-mirrors vendor finance job, built on manipulated data foundations that cannot be trusted, with a growing threat of ponzi-style real estate collapse and civil unrest if/when a brittle authoritarian regime loses control of the economic plot. (Not to mention the frightening anti-Japanese nationalism the mandarins may already have lost control of — while populism has long been a useful government tool for massaging viewpoints and distracting the domestic populace, the genie cannot be put back in its bottle when stakes start to grow alarmingly high. Wars have been fought for worse reasons.)

There has long been a certain moralistic, Calvinistic emphasis on the debt situation of the United States. In keeping with the country’s protestant roots, many have taken the intrinsically appealing view that excessive accumulation of debt is a sin and that too much sin must bear consequences. But this hypothesis driven more by an intuitive sense of morality than observable economic drivers does not fit the actual picture of what is happening, or the relative advantages and disadvantages of the US not just as creditor debtor, but as economic juggernaut with significant built-in advantages that not only show no signs of eroding, but could actually be increasing in worth. Think how much more attractive the United States will be, in relative terms as a destination, if global growth contracts over the next few years.

This touches on another key reason why the points are so confusing — the value of currencies and the desirability of liquid safe-haven assets are both expressed in relative terms. The dollar as a currency is considered in relation to the value of other currencies. United States’ government debt is considered in relation to the stability and attractiveness of alternative safe haven assets. On both these measures, in the real world the U.S. does far better than one might expect, with relative advantages of the United States vis a vis China and Europe again getting stronger, not weaker.

Could keep going, but trust the points are reasonably well made…

JS

 Have an excellent weekend!

Jack & Mike (jack@ / mike@ mercenarytrader.com)

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