FYI: This is an update to an article I had published in November 2006 in The Trader’s Journal: How the Poker craze can Help you Trade
I have been trading my own accounts for a decade now and I continue to learn more with each passing day. However, I never thought that a game, a hobby of mine, would advance my understanding and the importance of expectancy and position sizing as much as playing poker. Trading the markets and playing poker both require strict money management rules, stable emotional balance and a solid game plan. If you don’t consider and employ these tools, you will most likely fail sooner rather than later and lose a lot of money along the way.
So, how could a person learn so much from a game that most people consider luck? And why do some traders continually profit year after year while others lose their shirt while making the same mistakes? I will discus the basics of position sizing and expectancy and show you how both items are extremely important when trading and playing poker for profits. I will also close the gap of how each entity (trading and poker) have helped me become better at both.
Many people consider trading and poker pure luck but this is not an accurate observation. Average traders and average poker players taint the outside world with images of luck, quick riches and pure fantasy of the actual grind that is required to succeed. Many factors run parallel with poker and trading but the average Joe would never understand ‘why’ because he or she just listens to what the “talking heads” of television say. Luck may and will play a small part under certain circumstances but rules, odds, risk and money management are the largest components of the two entities.
It’s a grind; trading for a living and playing poker for a living is a grind – a full time business.
I don’t trade for a living but I do trade/ invest to grow my personal wealth. The savings and income from my main career is put to work through investing.
When investing in the stock market, it is essential to have a sound set of rules or a system that has been tested in real time, (back testing or historical testing is not required but can be used, my opinion of course). Back testing helps but playing sports has taught me that Monday morning quarterbacking is for theorists. Once a system has been tested profitably in real-time, the trader or poker player must follow clearly defined rules in order to preserve capital and cut losses. Both traders and poker players must consider the odds of their stock or hand making a gain or making a loss. Price objectives and targets should be a large part of every investor’s system but it is not the essential ingredient to success. Understanding how much to trade or how much to bet and exactly when to make that bet will be based on the system’s expectancy – and this should be the top priority.
So where does system development start? It starts by properly understanding position sizing techniques and calculated expectancies. Using these tools, the investor will be armed to trade only in situations where the odds are in his/her favor. A system that has been tested will have an approximate expectancy that will tell the trader or poker player how much will be gained or lost during each trade or hand over a period of time. Using this as one part of the equation, the investor or trader will now determine how much risk to undertake by calculating a position sizing algorithm that tells them how much to place on a specific trade or poker hand. The word “algorithm” may scare many people away but I have developed very simple position sizing and expectancy spreadsheets that can be found as a link on my blog. They can be downloaded, studied and tweaked without any advanced mathematical experience. This spreadsheet is strictly for trading, not poker.
Most traders and poker players look for three major factors when developing a system:
- How much to trade or bet
- The right odds or positive expectancy
- Multiple trades or hands to play (opportunity)
How do we Calculate Position Size (stock trading example)?