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OK lets talk IRONY
I just sat on my porcelain throne where I get some of my more enjoyable research .
I opened the June issue of SFO ( its free and occasional has something I find interesting) that I got in the mail yesterday.
Page 57 article
" TRADING AND GAMBLING More similar Than You May Like to Admit "
I havent read it yet but will today.
Ill try pasting article for non subscribers.
Life is full of risks, I think as I step on the scale and watch the numbers spin to a point they’ve never reached before. My weight would constitute an epic bull market if a technician were to chart it: a straight line up on high volume of trans-fats, carbohydrates and refined sugars. I am concerned and wish I could control my yearnings, but after years of futile efforts I have finally given up. We all have our shortcomings. Some men like strip clubs and have lovers on the side. I prefer strip steaks with fries on the side. I believe it was the great philosopher Ronald McDonald, who, paraphrasing Descartes, said, “I eat, therefore I am.†This more or less sums up my attitude.
I know that my insurance company’s actuarial tables say that on average, someone like me will die prematurely, but that is a gamble I am willing to take. The odds may be against me based on vast numbers of overweight middle-aged men, but in a large sample, averages can be misleading. Some percentage of fatties will live well beyond the average, and I think I’ll be one of them. Sure, I could throw out the Cap’n Crunch and eat brussel sprouts to improve the odds in my favor, but there is a quality of life consideration that cannot be ignored; I like Cap’n Crunch, and brussel sprouts taste, well, like brussel sprouts. In defining risk and reward and determining how much of each one is comfortable with, such matters only seem facetious on the surface.
As a professional trader, I probably have a more developed sense than most for the role gambling plays in our lives. After all, my days and nights consist of a series of trading decisions, every one of which is a gamble. Even the decision not to trade constitutes a gamble because the outcome of the decision to do nothing results in either the avoidance of a loss (hurray!) or the missing of an opportunity (*!@@!*). Whether active or passive, I am constantly trying to figure out the odds and turn them in my favor. What is the chance that the Bank of Japan will intervene? How likely is it that a stock that has closed lower for ten consecutive days will rally on Day 11? What is the probability that gold will stay above $600 per ounce, and how in the world did I miss the move from $450?
And yet, one need not be a trader to be forced to deal with risk literally every moment. Is it safe to walk down that dark street? Should I rent or buy? For a million dollars, is that your final answer? In fact, there is an endless series of decisions that every human being addresses in the course of daily life and varying degrees of risk and reward associated with each decision.
More Than Lady Luck
When I was a young trader, far less experienced in the markets and life than I am now, it bothered me whenever I heard anyone say that trading is nothing more than gambling. I don’t know which disturbed me more: the self-righteous “church lady†tone with which the comment was invariably offered, or the underlying suggestion that trading was a game of luck and that if traders were consistently making profits, the game must be fixed in their favor. It was easy enough to answer these critics. Luck, whatever role it plays, can be either good or bad, and on average (there’s that phrase again), the good and bad will cancel each other out. As for participating in a rigged game, I had plenty of losing trades to prove this contention false, and if there was a “conspirator’s ball†where the rules governing the grand scheme to defraud the unwashed trading masses were agreed upon, my invitation must have gotten lost in the mail. Still, I resented the implication that what I did for a living was tantamount to tossing a pair of weighted dice or playing cards with a marked deck.
Over time, however, I began to view things somewhat differently. It became obvious to me as my own account balance grew and as I watched other successful traders operate, that my best trades were ones in which I carefully considered the odds of a potential outcome and entered into transactions based on those expectations. In some cases, my entry and exit prices were determined by formal calculations that arose out of technical studies I performed each day before, during and after market hours. In other cases, I used my intuition and experience to guide me. For example, one of the single best trades I ever made occurred on the last trading day of the year. A very large order came into the pit and I knew I could make a wide price because many of the best traders were on vacation and there would be little competition for the trade. In other words, I would not have wanted to touch the trade at a price of X, which is where the market would have priced it had a normal amount of liquidity been available. But, at a price of X+25%, I had no qualms about making a market because the odds were weighted so heavily in my favor that a good outcome was virtually assured. Although I still deny the idea that the market is a fixed game, I am willing to admit it is very much a game — a game in which there are inefficiencies, such as the one described above, that a smart trader can use to advantage.
click image for larger view
Why the House Always Wins
It is beyond the scope of this article to compare trading to each of the familiar games one finds in casinos, but a fundamental principle that all casinos and all successful traders understand is that, irrespective of the game being played, if the house has a mathematical edge over the player, the law of averages ensures that in the “long-run†the house will win. In fact, for our purposes, an excellent definition of the “long-run†is enough games so that someone making good (bad) bets will win (lose). The number of games required for the desired or dreaded outcome is contingent on how good or bad the bets are.
The game of roulette offers a simple illustration of this truism. In American casinos, a roulette wheel consists of 38 slots into which the roulette ball can come to rest after the spin. Players can bet on 36 of the slots, with two slots reserved for the house. The house, however, pays off as if there were only 36 slots, collecting 2/38 of all money bet, or 5.26 percent. This is the house edge, which guarantees eventual profitability and ensures that the long-term gambler will leave the casino with little more than a discount coupon for Elvis World and—he hopes—his airplane ticket home. There are a number of bets one can place in the game of roulette. Bets are taken on single numbers or on combinations of two, three, four, six, 12 or 18 numbers. The fewer numbers chosen, the higher the odds (e.g., if one bets on two numbers the odds are 17 to one, while a bet on 18 numbers is an even money bet. Because these odds are for a 36-slot roulette wheel, not a 38-slot wheel, the house edge stays at 5.26 percent.)
We can show, mathematically, the rate at which gamblers will lose to the house. A full explanation of this phenomenon requires an understanding of various statistical distributions and the concept of standard deviation. However, leaving aside the math, it is still possible to appreciate the fundamental truth: The greater the number of bets against the edge, the greater the likelihood that the gambler will walk away a loser. Consider the following table, which enumerates the probability of earning a profit after various numbers of equal sized bets against various house edges. (The table comes from an excellent book called Probabilities in Everyday Life by John D. McGervey. McGervey is a professor of physics at Case Western University, so we can presume his calculations are accurate.) What is interesting about this chart is that it shows even with a tiny edge of 1.5 percent, the house still ends up the winner in the long run. Clearly there is no way to overcome the statistical certainties associated with the house edge. While it is possible for a gambler to make bad bets and get lucky for a period of time, this cannot last for more than a short while.
Counting Cards
So, if the key to winning in the long-run is obtaining the edge, how does one do that; in essence, how does a trader become the house? A look at the game of blackjack and the technique of card counting is instructive. In blackjack, the casino edge is relatively small (approximately one percent) and a smart player who knows when to draw additional cards and when to stand can bring the odds down to even. For example, you can make certain assumptions based on the dealer’s obligation to take or stand, and your own total, that will dictate your next move. There is a fairly long and complicated list of rules, and exceptions to those rules, that one must master in order to have a possibility of beating the house. Without going into the minutiae of the game, it is interesting that while ultimately luck governs which cards the player gets, playing blackjack seems a lot like trading the market. In order to be successful, one needs to take the opportunities presented and respond in a manner that allows the trader to capitalize best on those opportunities. In other words, with each hand (trade), one has to assess the probability of the outcome and bet (position) accordingly.
What card counters do is to pay close attention to each hand while they are playing at a table and keep track of the cards that have been dealt. Their goal is to find advantageous situations—specifically, when a lot of small cards have been dealt and the deck is rich with tens and aces. At that point, the odds switch in favor of the bettor, giving an edge of one to two percent over the house and allowing the bettor to increase the sizes of his/her bets. Casinos do not want card counters—well, not good card counters; bad card counters are welcome to stay until their money runs out—for the simple reason that a good card counter can actually win in the long run, and taking a long-run risk is completely antithetical to the fundamental principle upon which all casinos are based. Casinos have made it difficult for card counters to succeed by raising the number of decks used at a table, thus forcing the card counter to remember increasingly large sequences of hands dealt.
Ironically, while this reduces the number of advantageous situations, these situations do still occur, and because there are multiple decks they continue on for longer than they would if only, say, two decks were being used. Casinos will banish card counters when they catch them, which eventually leaves the card counter with few places to count cards. Nevertheless, card counting individuals and teams persist in trying to outsmart the casinos and take the house’s money, and some must be doing it successfully.
Stick to the System
In fact, Blair Hull, who, before he became a legendary trader, was part of a card-counting team in Las Vegas, has said about the practice,“If I had no money, there is no doubt in my mind about where I’d go.†He also has said something that every trader ought to think about: “It’s not the mathematical skill that’s critical to winning, it’s the discipline of being able to stick to the system. There are very few people who can develop the skills to get the edge, and far fewer still who can withstand the losses emotionally and stick with the system. Probably only one in five hundred people has the necessary discipline to be successful.â€
One in five hundred! As hyperbolic as that may sound on the surface, I wouldn’t bet against it. In fact, if Hull’s definition of a successful trader is, well, Blair Hull, then 500 to one sounds generous. I also have to agree with his assessment that while players (traders) possessing the skills required to be successful are infrequently found, rarer still are those who have the discipline to execute the rules that must be implemented in order to succeed.
As far as I’m concerned, this lesson, that success follows discipline, is the most valuable thing we can learn in trying to compare the games we play with the markets we trade. So, maybe, just maybe, I’ll try the brussel sprouts. I hear they taste really good if you smother them in butter.
I just sat on my porcelain throne where I get some of my more enjoyable research .
I opened the June issue of SFO ( its free and occasional has something I find interesting) that I got in the mail yesterday.
Page 57 article
" TRADING AND GAMBLING More similar Than You May Like to Admit "
I havent read it yet but will today.
Ill try pasting article for non subscribers.
Life is full of risks, I think as I step on the scale and watch the numbers spin to a point they’ve never reached before. My weight would constitute an epic bull market if a technician were to chart it: a straight line up on high volume of trans-fats, carbohydrates and refined sugars. I am concerned and wish I could control my yearnings, but after years of futile efforts I have finally given up. We all have our shortcomings. Some men like strip clubs and have lovers on the side. I prefer strip steaks with fries on the side. I believe it was the great philosopher Ronald McDonald, who, paraphrasing Descartes, said, “I eat, therefore I am.†This more or less sums up my attitude.
I know that my insurance company’s actuarial tables say that on average, someone like me will die prematurely, but that is a gamble I am willing to take. The odds may be against me based on vast numbers of overweight middle-aged men, but in a large sample, averages can be misleading. Some percentage of fatties will live well beyond the average, and I think I’ll be one of them. Sure, I could throw out the Cap’n Crunch and eat brussel sprouts to improve the odds in my favor, but there is a quality of life consideration that cannot be ignored; I like Cap’n Crunch, and brussel sprouts taste, well, like brussel sprouts. In defining risk and reward and determining how much of each one is comfortable with, such matters only seem facetious on the surface.
As a professional trader, I probably have a more developed sense than most for the role gambling plays in our lives. After all, my days and nights consist of a series of trading decisions, every one of which is a gamble. Even the decision not to trade constitutes a gamble because the outcome of the decision to do nothing results in either the avoidance of a loss (hurray!) or the missing of an opportunity (*!@@!*). Whether active or passive, I am constantly trying to figure out the odds and turn them in my favor. What is the chance that the Bank of Japan will intervene? How likely is it that a stock that has closed lower for ten consecutive days will rally on Day 11? What is the probability that gold will stay above $600 per ounce, and how in the world did I miss the move from $450?
And yet, one need not be a trader to be forced to deal with risk literally every moment. Is it safe to walk down that dark street? Should I rent or buy? For a million dollars, is that your final answer? In fact, there is an endless series of decisions that every human being addresses in the course of daily life and varying degrees of risk and reward associated with each decision.
More Than Lady Luck
When I was a young trader, far less experienced in the markets and life than I am now, it bothered me whenever I heard anyone say that trading is nothing more than gambling. I don’t know which disturbed me more: the self-righteous “church lady†tone with which the comment was invariably offered, or the underlying suggestion that trading was a game of luck and that if traders were consistently making profits, the game must be fixed in their favor. It was easy enough to answer these critics. Luck, whatever role it plays, can be either good or bad, and on average (there’s that phrase again), the good and bad will cancel each other out. As for participating in a rigged game, I had plenty of losing trades to prove this contention false, and if there was a “conspirator’s ball†where the rules governing the grand scheme to defraud the unwashed trading masses were agreed upon, my invitation must have gotten lost in the mail. Still, I resented the implication that what I did for a living was tantamount to tossing a pair of weighted dice or playing cards with a marked deck.
Over time, however, I began to view things somewhat differently. It became obvious to me as my own account balance grew and as I watched other successful traders operate, that my best trades were ones in which I carefully considered the odds of a potential outcome and entered into transactions based on those expectations. In some cases, my entry and exit prices were determined by formal calculations that arose out of technical studies I performed each day before, during and after market hours. In other cases, I used my intuition and experience to guide me. For example, one of the single best trades I ever made occurred on the last trading day of the year. A very large order came into the pit and I knew I could make a wide price because many of the best traders were on vacation and there would be little competition for the trade. In other words, I would not have wanted to touch the trade at a price of X, which is where the market would have priced it had a normal amount of liquidity been available. But, at a price of X+25%, I had no qualms about making a market because the odds were weighted so heavily in my favor that a good outcome was virtually assured. Although I still deny the idea that the market is a fixed game, I am willing to admit it is very much a game — a game in which there are inefficiencies, such as the one described above, that a smart trader can use to advantage.
click image for larger view
Why the House Always Wins
It is beyond the scope of this article to compare trading to each of the familiar games one finds in casinos, but a fundamental principle that all casinos and all successful traders understand is that, irrespective of the game being played, if the house has a mathematical edge over the player, the law of averages ensures that in the “long-run†the house will win. In fact, for our purposes, an excellent definition of the “long-run†is enough games so that someone making good (bad) bets will win (lose). The number of games required for the desired or dreaded outcome is contingent on how good or bad the bets are.
The game of roulette offers a simple illustration of this truism. In American casinos, a roulette wheel consists of 38 slots into which the roulette ball can come to rest after the spin. Players can bet on 36 of the slots, with two slots reserved for the house. The house, however, pays off as if there were only 36 slots, collecting 2/38 of all money bet, or 5.26 percent. This is the house edge, which guarantees eventual profitability and ensures that the long-term gambler will leave the casino with little more than a discount coupon for Elvis World and—he hopes—his airplane ticket home. There are a number of bets one can place in the game of roulette. Bets are taken on single numbers or on combinations of two, three, four, six, 12 or 18 numbers. The fewer numbers chosen, the higher the odds (e.g., if one bets on two numbers the odds are 17 to one, while a bet on 18 numbers is an even money bet. Because these odds are for a 36-slot roulette wheel, not a 38-slot wheel, the house edge stays at 5.26 percent.)
We can show, mathematically, the rate at which gamblers will lose to the house. A full explanation of this phenomenon requires an understanding of various statistical distributions and the concept of standard deviation. However, leaving aside the math, it is still possible to appreciate the fundamental truth: The greater the number of bets against the edge, the greater the likelihood that the gambler will walk away a loser. Consider the following table, which enumerates the probability of earning a profit after various numbers of equal sized bets against various house edges. (The table comes from an excellent book called Probabilities in Everyday Life by John D. McGervey. McGervey is a professor of physics at Case Western University, so we can presume his calculations are accurate.) What is interesting about this chart is that it shows even with a tiny edge of 1.5 percent, the house still ends up the winner in the long run. Clearly there is no way to overcome the statistical certainties associated with the house edge. While it is possible for a gambler to make bad bets and get lucky for a period of time, this cannot last for more than a short while.
Counting Cards
So, if the key to winning in the long-run is obtaining the edge, how does one do that; in essence, how does a trader become the house? A look at the game of blackjack and the technique of card counting is instructive. In blackjack, the casino edge is relatively small (approximately one percent) and a smart player who knows when to draw additional cards and when to stand can bring the odds down to even. For example, you can make certain assumptions based on the dealer’s obligation to take or stand, and your own total, that will dictate your next move. There is a fairly long and complicated list of rules, and exceptions to those rules, that one must master in order to have a possibility of beating the house. Without going into the minutiae of the game, it is interesting that while ultimately luck governs which cards the player gets, playing blackjack seems a lot like trading the market. In order to be successful, one needs to take the opportunities presented and respond in a manner that allows the trader to capitalize best on those opportunities. In other words, with each hand (trade), one has to assess the probability of the outcome and bet (position) accordingly.
What card counters do is to pay close attention to each hand while they are playing at a table and keep track of the cards that have been dealt. Their goal is to find advantageous situations—specifically, when a lot of small cards have been dealt and the deck is rich with tens and aces. At that point, the odds switch in favor of the bettor, giving an edge of one to two percent over the house and allowing the bettor to increase the sizes of his/her bets. Casinos do not want card counters—well, not good card counters; bad card counters are welcome to stay until their money runs out—for the simple reason that a good card counter can actually win in the long run, and taking a long-run risk is completely antithetical to the fundamental principle upon which all casinos are based. Casinos have made it difficult for card counters to succeed by raising the number of decks used at a table, thus forcing the card counter to remember increasingly large sequences of hands dealt.
Ironically, while this reduces the number of advantageous situations, these situations do still occur, and because there are multiple decks they continue on for longer than they would if only, say, two decks were being used. Casinos will banish card counters when they catch them, which eventually leaves the card counter with few places to count cards. Nevertheless, card counting individuals and teams persist in trying to outsmart the casinos and take the house’s money, and some must be doing it successfully.
Stick to the System
In fact, Blair Hull, who, before he became a legendary trader, was part of a card-counting team in Las Vegas, has said about the practice,“If I had no money, there is no doubt in my mind about where I’d go.†He also has said something that every trader ought to think about: “It’s not the mathematical skill that’s critical to winning, it’s the discipline of being able to stick to the system. There are very few people who can develop the skills to get the edge, and far fewer still who can withstand the losses emotionally and stick with the system. Probably only one in five hundred people has the necessary discipline to be successful.â€
One in five hundred! As hyperbolic as that may sound on the surface, I wouldn’t bet against it. In fact, if Hull’s definition of a successful trader is, well, Blair Hull, then 500 to one sounds generous. I also have to agree with his assessment that while players (traders) possessing the skills required to be successful are infrequently found, rarer still are those who have the discipline to execute the rules that must be implemented in order to succeed.
As far as I’m concerned, this lesson, that success follows discipline, is the most valuable thing we can learn in trying to compare the games we play with the markets we trade. So, maybe, just maybe, I’ll try the brussel sprouts. I hear they taste really good if you smother them in butter.
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