Friday, March 6, 2009

Another Poker Analogy

In online poker, all the chips on the table have been paid for, and with each subsequent pot the house takes its "rake" (i.e. a small fraction for hosting the game). Any money you make in online poker comes out of the pockets of those who you are playing against, and even if you were the best poker player on the table and looted all the stacks, you still wouldn't leave with all of the money that had been on the table. This is because of the rake fee.

The stock market is similar. All of the money you make comes from the pockets of the other participants. After each trade a commission fee takes place to cover the transaction between the two individual traders/investors (players). At the end of the day, even if you were the best trader in the world and were able to drain the participants of all their capital (impossible for many reasons, but for theoretical purposes--) you would still walk away with less money than had been put into the market (sans dividends, should the stocks have any) because of broker fees.

I guess the message I am trying to get across here is that for every winning hand or profitable trade, there will be a losing hand or a losing trade on the other side, at least when markets grow faster than the underlying companies and economy. Those who come out on top are relatively few, because they tend to obtain the "stacks" with their confidence, skills, and eventual ability to buy the pot. The others who come out on top (assuming they have a good business model and aren't wasting money on excess people/equipment) are those who bring the transactions together.

Oh, and another thing: on average, people like to think they are better than average poker players. I think the same goes for the financial world.



Charlie G. said...

I think in every endeavor - to be good at it - you have to balance humility with confidence, to truly excel.

In something like golf, if you have a misguided inflated view of your ability, well, at worst you will be annoying and you will lose - but there's side benefits like exercise, socialization, fun no matter what. But if you are a little grandiose about being above average, no harm.

But in a zero sum game with high stakes - I think that is why so many people don't exceed at trading - they don't recognize their weaknesses or the risks, maybe don't even understand the odds. But if you don't have some faith in your capabilities, you won't get far because of the hard work.

I don't know if there are any side benefits from trading and losing - it's stressful and you go broke. And if you are doing it for fun or your social life....good luck. There's always - I'm a better person because of.

Poker RAKE = e.g. commissions

Trading SLIPPAGE (bad fills, etc.) = blinds when you have a bad cards but are force to put money in the pot without looking at what you got?

Mark said...

I think the reason people are successful in poker is they can exploit peoples emotions and bad calls. I think that is the reason poker is different than say a slot machine or a game with the odds against you. Trading the stock markets are similar bc very smart people will make dumb mistakes or drive a stock down to far to a point others will see value in it. That doesn't happen to frequently but it happens a good bit.

Mark said...

when I look at trading intraday I'm not mostly thinking of taking anybody's money. In stocks on the Naz, NYSE AMEX the real battle is between the instituitions and hedge funds with size. Because of our size it is better for us to just view trading as jumping on the backs of these giants and stealing some of their tiny crumbs of liquidity. Another analogy is say you are an ant with two giants in a boxing ring. it is best to run around and feed off the carnage between the two. That's why we have to move quick intraday and anticipate a move and jump on their back then get off quick.

Complacent Panda said...

I agree with you Charlie. I think your first comment is a must. The market is too big to allow another ego to rival it.

Mark, I concur with your giant analogy. Fundamentally, however, you are still taking others' money, although indirectly through another entity (the hedge fund or mutual fund that those people "invested" in).

I like the elaborations =)

Anonymous said...

Both poker and the financial markets are, to a first approximation (ignore rake, spread etc),zero-sum games.

When you are having a bad trading day you just have to think of the average inteliigence of the participants in those two zero-sum games.

I'm off to play poker!