An old rule of thumb is: “If you don’t know what your edge is, you don’t have one.”
That statement is a helpful clarity filter. If you have a winning program, you should be able to articulate what makes you successful (especially in the context of a zero or minus sum game).
The phrase is unhelpful, though, in the way it muddies the waters. The single edge notion is a misnomer. A winning player has a critical mass accumulation of edges that all come together.
Because of this, it’s often a red herring, or a source of misdirection, to try and assign one or two large-scale reasons as to why a trader is profitable. There might be dozens of small-scale reasons, or something to that effect.
We can think about this in the context of decision making at the poker table. Consider the following basic assumptions:
The typical casino room poker dealer, utilizing a table shuffle machine, deals about 35 hands an hour.
A skilled practitioner might play 20% of hands over time, and make important folding decisions another 20% of the time preflop. (The hands you avoid matter too.)
This works out to (roughly) 25 decisions per hour: 7 hands played to a flop or beyond… another 7 hands folded with discretion based on context (as opposed to insta-mucking queen-deuce offsuit etc)… and another dozen or so decisions in post-flop play. (Total = 26, rounded down to 25.)
By this estimation, the typical 5 hour session (4 to 6 hours of play) means 125 decisions.
A statistically meaningful block of time — to iron out luck, variance, outliers etc — is about 100 hours, or twenty sessions. Any single session can be an outlier good or bad, but 100 hours of play gets you into relevant territory.
Over twenty sessions or 100 hours of play, at 125 decisions per hour, the skilled poker player has 2,500 decisions to make… which represents 2,500 opportunities to cement cumulative edge.
Keeping in mind too that, if you really want to iron out the flukes, even 100 hours is a relatively modest unit of measurement. Taking it to a thousand hours — the equivalent of six months at a 40-hour-a week job — will really ensure whether the edge is there or it isn’t.
At that level, the skilled player has 25,000 chances to show superior quality… a compounding sum indeed…
Now, will all of those 25,000 decisions matter equally? Will they all have the same weight, the same impact on results? Of course not.
A relatively small percentage of decisions will have a gigantic impact on net outcome… decisions where very large pots, or entire stacks, are won or lost / protected or exposed.
(For the sake of simplicity, we won’t get into deep structure poker tournaments — but the outlier character of a few key decisions is even larger there.)
Then, in addition to the small percentage of massively important decisions, there are countless thousands of lower-stakes decisions that add up to big money via cumulative impact.
Twenty dollars here, fifteen dollars there, fifty dollars over there… get sloppy at the margins dozens of times a night and it gets expensive fast.
The vast majority of players — even those who think of themselves as “professional,” which is often code for “I don’t have a job” — do not think like this.
They don’t comprehend the sheer granularity of the game… how much the little decisions matter, and how important it is to get the big outlier decisions right. (Hello Risk Control!!)
Having an edge in poker, then, can be expressed in all kinds of generalized ways: Proper capitalization. Proper discipline. Theoretical grounding. Consistency in small pots, risk control in large pots, max extraction with the nuts, and so on.
But all of that can be boiled down to a simpler proposition: The ability to make consistently superior decisions, and consistently fewer mistakes, over an extended period of time.
In this manner the skilled player is like “the house” in blackjack. Casinos welcome visitors to their blackjack tables because, even if you play with 100% theoretical correctness — a hard thing to do after three drinks — the casino still maintains a roughly one half of one percent probabilistic edge. (Unless the hospitality team gives it away by mistake, as with this guy.)
Point being, even with an edge as thin as half a percent, the law of large numbers compounds to a point of near certainty.
There is a reason why casinos sell blackjack strategy cards in the commissary shops, and why all those blackjack dealers have jobs!
This further helps explain why the tourist or “casual” player is so hopelessly outgunned. There is a chance of “getting lucky,” certainly. But profitability over an extended cycle will be the cumulative result of good decisions made and bad decisions avoided, on a compound basis over time.
To get that you need repeated trials and consistent execution, over and over again. You need the patience of an unhurried regular.
There is admittedly a conceptual flaw in comparing a winning poker player to the house take in blackjack. In blackjack, the house edge is mathematical and statistically embedded in the rules. You can’t overcome it without counting cards or making high roller side deals with weak-minded staff.
The winning poker player’s edges, in contrast, are much more varied and subtle.
Go back to that roster of 25,000 decisions over a thousand hour period. That multitude of decisions will cover what one might call a possibility landscape, in which all manner of outlier scenarios will cycle through, requiring all manner of nuanced knowledge expression as the correct moves are made.
Good runs, bad runs, wacky flops, epic suckouts, nightmare beats, super-nuanced weird or bizarre scenarios that come up almost never, and so on… It takes experience, an unflappable nature, and a very strong core process to handle all that with optimal precision, which in turn results in max profit.
And to a large degree the manifestation of this edge is invisible. The bad player does not recognize the good player simply via straight-up observation. If the good player sits down with the same group of bad players over a long enough time period, the bad players simply get a nagging feeling: That guy always seems to win. (And the nagging feeling will be justified. Over a tracking period approaching 400 hours of play, our internal Maker stats show a cash game “winning session” percentage of 70%.)
Now let’s move the discussion over to trading. What does a trading edge look like? Some ruminations…
Trading is far more complex and nuanced than poker, due to the far larger possibility landscape. But, for the sake of example, we can make some simplifying assumptions…
A discretionary swing trader with a multi-day to multi-week time frame might make, say, twenty trades a month on average (some months more, some months less).
Each of these trades involves at least four decisions:
- When to enter
- Where to set the risk point
- When to exit (assuming RP not hit or otherwise adjusted)
- How much size (how big to make the trade)
Nor does the above consider partial profit taking, pyramiding, holistic portfolio decisions, hedging strategies, and so on.
From a basic bread-and-butter standpoint, though, twenty trades per month creates the potential for eighty separate decisions. And in reality there are many more decisions than that, as the trader has to decide which tempting trades to “fold preflop”… i.e. potentially attractive setups not taken for various filtering criteria reasons…
Then there are meta-level decisions to be made regarding things like:
- Base levels of aggression relative to market conditions
- Levels of drawdown tolerance relative to equity curve
- Strategy implementation relative to market environment
- “Special tools” – special situation trades, structures etc.
And on top of that there are decisions as to where to direct research efforts… which research leads to follow up and which to back burner or the discard pile… potential R&D adjustments to the current methodology… whether to tweak at the margins in periods of adversity or stay with the tried and true… and on it goes…
Put all the above together and our baseline discretionary swing trader, who “only” makes twenty trades per month on average, still has to make something on the order of 200 decisions — remember all the stuff that’s said “no” to — all of which have a potential impact on cumulative net results…
So it’s fairly safe to say: As an active trader, you could literally be making thousands of decisions per year!
And just as with poker, your net will be the cumulative result of your decision-making quality (good diluted by bad)… with the stuff you leave out as potentially impactful as the stuff you put in…
You might have noticed that, in terms of sheer decision making numbers, poker beats trading by an order of magnitude.
But trading ultimately trounces poker for a couple reasons:
In trading the pot size is virtually unlimited. If you flop aces full of kings in a cash game, you can’t say “excuse me guys, let me just run out and add $50,000 to my stack.” With trading, in contrast, in those rare situations where an absolute dream opportunity comes up, it is possible to participate in gargantuan size, with capped downside risk. While high stakes cash games can get ridiculous (think hundreds of thousands on the table), the stakes will always be peanuts compared to the potential depth of opportunity in trading.
In trading huge opportunities can last for months, quarters, or even years. An excellent trading methodology is one that allows for large size on initial entry, via carefully managed risk point, coupled with an ability to “open up the envelope” on truly excellent positions that can run and run like the energizer bunny… and offer opportunities to pyramid along the way. Think of sick runs like crude oil transitioning from hovering above $10 per barrel to nearly $140 pre-crisis, or stocks like Enron falling from hundreds of dollars per share to zero.
In trading you can make money while you sleep. Poker requires a presence at the table in order to win. You can’t hire someone to drag the pots. With trading, in contrast, you can put a great position on and then sit back and let it work. If you are riding a great trend, the trend will keep going while you fish on your boat or play with your kids. Patience, aka the ability to “sit tight,” is a time saving virtue in that regard. As Jesse Livermore once said (via Reminiscences),
“After spending many years in Wall Street and after making and losing millions of dollars I want to tell you this: it never was my thinking that made the big money for me. It was always my sitting. Got that? My sitting tight!”
In this piece we haven’t touched on the dynamics of all those decisions — thousands, tens of thousands — and the detail that actually goes in.
A deeper purpose of this exercise, though, is to demonstrate at least three things:
- A real edge is more durable than most realize.
- Developing a real edge takes EFFORT!
- The long run investment is WORTH IT.
There are optimists who come into trading (or poker) expecting it to be easy. But this notion never made much sense. Why would a zero sum game — in which whatever profit you extract comes from your fellow participants, with house vigorish on top — be easy?
Reaching the promised land of consistent profitability will not be easy. It will be hard. Like “training for a triathlon” hard.
That’s the bad news. The good news is this: The fact that it’s so hard is part of what validates the edge as real.
And as a corrollary, the hardness of the endeavor is what makes it so profitable. If you figure out how to win, you can win a LOT (as your typical opponents trade luck with each other, stay mired in the realm of mediocrity, and generally let you capitalize on their mistakes).
The ultimate validator is consistent results over time. But conceptual grounding is important too, to rule out the possibility of an extended lucky streak.
And given the challenges of making consistent high quality decisions over thousands and thousands of instances… and doing this with proper mindset, capitalization and theory… having accumulated the necessary experience and situational memory to excel at all levels of the endeavor… well, given that tough-as-nails laundry list of what’s required, is it any wonder at all that 95% of those who take a shot at poker and trading fail to attain consistent profitability?
Is it any wonder whatsoever, when so few even bother to adopt a training mindset, or give themselves a fully legit chance in the first place?
Some background: This piece was wholly composed from a seat at table 25, in the midst of a 2-5 NL cash game, in the high speed internet equipped Wynn poker room in Las Vegas.
At the (literal) time of this writing, the table is populated with fish and yours truly. Some are undercapitalized relative to the table stakes. Others are impatient and playing far too many hands. Still others think poker is what they’ve seen on youtube, and as a result are making laughably bad bluffs. At least two or three have lost a substantial amount (including multiple feltings) due to visible frustration and lack of emotional control.
Overlaid with the tourists are the “grinders,” players who are almost always short-bankrolled and worried too much about the money. This fear, plus a lack of theoretical completeness, causes them to forfeit a whole class of opportunities relating to stack path optionality and fold equity, which hurts their profit.
And then you have the “ballers,” who may have won a nice sum on a tournament hot streak and labor under the misconception that poker is all about testosterone and making moves. (Aggression yes, but CONTROLLED aggression.) These players most closely resemble the profile of the naked option seller — they hoover up small pot after small pot with their strong-arm tactics, then inevitably blow up their stack…
(A few feet away, on the Wynn poker room upper deck, there is a 25-50 NL game in play. This game is not just 10 times bigger, it is more like 100 times bigger. Circa 20 minutes ago, someone dragged an $80,000 pot with pocket fives. The players in this game are often not better — just richer via outside means. In fact the cavalier nature of the money can make them worse. One of these days…)
The world of trading and investing is more professional but, arguably, in a lot of ways much the same — populated with “pants-wearing monkeys” to use a Barry Ritholtz phrase. Institutional money managers “play too many hands” in respect to always being in the market and over-biased long. Their size forces them to move slowly, leaving elephant-size footprints and telegraphing their intentions.
Meanwhile, investors as a collective behave like their own worst enemy. They panic and dump at the bottom, or get frenzied and blow out at the top. They push hard while stampeding, but prove fantastically wrong at turning points. On top of all this, intrusive governments and central banks do predictably stupid things — exploitable things — in the name of short-term can kicking.
These are the games we love (poker and trading)… which is why we are successful in the first place, via the meta-level “edge” of being stone cold passionate — flat-out obsessive even — about what we do.
So how do you develop a durable and powerful edge… a true edge, one that can make you some serious dosh, by manifesting itself across thousands and thousands of decisions, traversing the breadth and depth of the possibility landscape?
You do it the same way you eat an elephant — one bite at a time.
As mentioned in a recent TW, “Mastering the Art,” we are obsessed with the interrelated crafts of poker and trading.
Which is partly why we’re excited about teaching in 2013…
How much benefit could there be in taking both new and seasoned traders through all aspects of a trading program? Everything from psychology to trade monitoring to position sizing spreadsheets — all in a coherent framework.
We want to do this not just to share, but to push the envelope on our own processes… keeping the edge honed to a gleam.
Psychology is at the heart of the matter. Cultivating and maintaining the proper mental state is like putting in the foundation substructure… it is what has to exist before the foundation — good decisions — can even go in.
(And yet, ironically, how many aspiring traders, poker players etc. put psychology first?)
This is why we will be opening the 2013 reintroduction of the Mercenary Driver’s Manual with one of the most powerful special reports we have ever produced: The MT Trading Psychology Field Guide.
And from there — with psychology as the substructure — we can start helping traders eat their PEAs (positive edge accumulators) one by one, on the path to deep level edge development as the DM unfolds… take a look!