Day Trading – Essence of Trading

July 14, 2014May 17, 2017

5 Similarities Between Profitable Day Traders And Professional Poker Players

I was having fun talking to an old friend who has been playing poker professionally for many years. He is one of those players who consistently making money from playing in poker halls and tournaments but seldom show up in the final tables. During our conversation, he raised the issues of player statistics and how the top players all play similarly statistically speaking. Even more interesting, he thinks the statistical behaviour of the professional poker players is very similar to consistently profitable day traders.

I did some research on the subject and can now confirm what my buddy told me is true. Here are 5 similarities between the professional poker players and profitable day traders that no one pays attention to.

Similarity 1: Very Selective

Non-professional poker players play at least three out of five games.

Professional poker players play only one out of five games.

The figure goes even lower to one out of ten during major tournaments. What it implies is that the professional poker players are willing to bleed chips until the right combinations show up. It is not just your hand that matters. It also depends on what is showing on the table at the time including the behaviour of your opponents and the cards that are visible on the table.

Profitable day traders are doing exactly the same thing when they trade.

Good day traders have the patience to wait for the right setup. More importantly, they scratch when the scenario is unfolding in ways reducing the predictability of the outcomes. In this sense, profitable day traders scratch as many trades as the number of games that the professional poker players give up in tournaments.

Beginners in day trading do not understand that scratching is perfectly valid and necessary as long as the decision is not made due to emotional influence. Having brass balls holding onto your trading mistakes does not make you a good trader. Having the courage to admit that you are wrong will allow you to focus on what is more important – the next trade.

Similarity 2: Well Prepared

Professional poker players are busy. When they are not taking a break they join as many tournaments as they can. It is not that they like to gamble. They understand that the more you play, the more likely the law of large numbers can work for you. They treat their poker games very seriously like a regular business.

Professional poker players also keep up their skills by studying the odds in various scenarios so that they are prepared in handling them when they encounter these difficult situations. It is not how well a poker player playing a perfect hand that counts. It is how well a poker player handles the difficult scenarios to stay out of trouble that protect their bottom lines.

Profitable day traders also use their time wisely when not monitoring the markets in real-time. They conduct research, review their own performances and keep up with latest financial world developments. The time and effort spent help these day traders stay competitive.

Similarity 3: Consistency

The statistics on professional poker players are very consistent. The top players all ended up behaving very similarly if only performance metrics are compared. In other words, the style of a professional poker player does not matter much on pure performance sense. The net winnings may vary a lot among the top players. But that is caused by the limited number of major tournaments available in comparison to the number of active professional poker players.

What this means is that the professional poker players have their emotions under control most of the time during tournaments. They understand that they have no control of the cards in each hand but they can control their responses to management the impact of the game on their overall performance. Hence they try their best not to invest too much emotion into any particular hand they are playing which allows them to perform more consistently.

In essence these professional poker players function like machines during the games. All the odds and scenarios are recalled from memory during the games to minimize guesswork. Many amateurs who have the luck to play against these professionals describe their encounters as facing the Terminators.

Majority of traders do not realize that they have no control over the markets they trade. There is no such thing as certainty in the markets similar to what the poker players are facing. Great day traders are well prepared like the professional poker players that they do not really waste any time analyzing the markets while trading. They merely execute their plans. This reduce their chance of making mistakes and promote consistency in their performance.

Similarity 4: Beat The Amateurs Not The Game

Professional poker players prefer large scale tournaments over the small scale ones. The main reason is that it will reduce their chances of facing very strong opponents in the first few rounds of the tournaments. The more amateurs in a tournament, the more likely the professional poker players can rank higher among the participants. Higher ranking alone means the odds of getting payout is greatly increased. Professional poker players are looking for income from the tournaments, making a killing is just bonus.

Profitable day traders understand that financial markets are like American football where the participants are all part of the game. It is not how great you are in absolute terms that matters. It is how weak your opponents are relative to you that allows you to beat them.

Hence good day traders seek for markets with better liquidity to find good trading opportunities. What it really means is that they are looking for higher concentration of amateurs to take advantage of.

Similarity 5: Profitable Excluding Outliers

Out of all the tournaments a professional poker player played, getting to the top 10% in a tournament only happens 10% of the time. It is long term statistics though. If you only look at a short time window (e.g. yearly), you may find some of these professional poker players getting to the top 10% in 30% (or even more) of the tournaments participated.

The winnings from those top 10% tournament winnings contribute approx. 50% of the winnings the professional players make. The other 50% of their winnings coming from the 50% of tournaments they participated in where they land at the top 50% but not making it into the top 10%. In another words, the professional poker players made money from 60% of the tournaments they participated in. They lose the buy-in in the rest of the tournaments they played.

What separate professional poker players from amateurs in terms of profit distribution?

professional poker players can net positive without the winnings from the exceptional top 10% winnings
professional players have 10% chance of getting to the final table while the amateurs stand at one percent

(Note: Since I cannot gather statistics on professional poker players whose specialty is poker hall cash games, I cannot tell if the same statistics is applicable to them.)

Good day traders are profitable without the glory trades nor the home runs. Make no mistake, those winnings add much to the bottom line similar to the professional poker players. But one has to realize that these winnings happen by chance thus one does not necessarily get them regularly. Good day traders can make sure their trading styles will allow them to capture the exceptional runs when they happen but that is all they can do.

Future Outlook

My friend pointed out that the professional poker players is an ever increasing crowd. It has been steadily increasing ever since the internet and TV popularize poker games. It used to take training partners and many face to face games to horn your skill. Now, if an individual is dedicated enough by memorizing the thousands of scenarios with the related odds in a particular poker game and improve skills through playing online pokers, one can become a professional in a few short years.

The problem, however, is that the big money is concentrated in major tournaments. When there are more professional players playing them, the less likely one can get to the top 10% for the major payouts. The retirement age for professional poker players is quite high as peak performance of the brain is not as brutal as physical intensive activities like sports. Hence the number of professional poker players will keep increasing and dilute the prizes unless more major tournaments are created with more prize money.

Professional poker players can always choose to play the poker hall cash games. The upside is more limited but you have the advantage of anonymity and flexibility with your work schedule. The downside is that you need the extra skillset to control your winnings so that you do not upset the crowd who feed you.

For day traders, since way too many participants are delusional with magic top and bottom picking techniques, the increase in number of profitable day traders is not as fast as the professional poker scene. The complexity of the markets blinds people from accepting the facts that price movements in all markets boil down to the order flow. Hence the financial industry will always find ways to talk their books and line their pockets at the expense of the ignorant public.

As financial markets worldwide keep growing in size and variety, the good day traders are getting more ways to stay profitable and more chances to make good money. In terms of future outlook, being good at day trading has more upside potential than professional poker playing.

Sources

Identifying Online Professional Poker Players: A Revealed and Stated Analysis Approach, Kahlil Philander, Brett LL Abarbanel – 2011

Poker Superstars: Skill or Luck?, Rachel Croson, Peter Fishman and Devin G. Pope

Quality of Professional Players’ Poker Hands In Perceived Accurately From Arm Motions, Michael L. Slepian, Steven G. Young, Abraham M. Rutchick and Nalini Ambady

What’s It Like To Earn A Living Through Poker?, Michael Shinzaki

December 19, 2012May 17, 2017

Essence of Trading: The Three Pillars of Critical Thinking (Part 4)

… continue from part 3

"The only thing more expensive than education is ignorance"

– Benjamin Franklin

Self-correction is the most difficult part in critical thinking. We may be very logical in analyzing a situation. We can be very objective in evaluating things. Yet, it is very difficult to apply these two skills onto ourselves. Overcoming this barrier is important in giving us the ability to control our weaknesses in trading and adapt to the ever changing market environment.

Self-correction is a multiple step process. First, we need to identify a potential problem within ourselves. Then, a correction strategy has to be derived. Finally, follow the the strategy to correct our beliefs, or condition our minds to take on the preferred behaviour over the original one.

Obstacles Against Self-Correction

First obstacle to self-criticism is our natural tendency to lie to ourselves. It is in fact a normal behaviour among majority of adults to overestimate their skills and down play their share of mistakes in something that failed to workout. It is an essential psychological make up for human to be more forgiving to themselves so that they would survive the hardship in life. This innate quality makes judging ourselves critically especially difficult.

Second obstacle is our inability to correct existing behaviours. This tendency in human enabled our species better survival chance in the natural environment. It is to our best interest to not question our ability when we are living in the wild. Casting doubts on one self can lead to hesitation. In life or death situations, such hesitations can be the end of our lives.

As in animal kingdom, the necessary skills for survival are all developed in the early age of an animal’s life. Specialized skills like hunting are trained from observation and game play among peers. There is no learning and correction after that once the animal hunters are on their own. The main corrective function is shut off for good after an animal has reached adulthood. Since our bodies including the brains are still mainly a copy of our ancient ancestors, it is no surprise that majority of us have difficulties correcting or changing our behaviour once we reached mid 30s.

Two out of the three steps making up the self-correction process are against our nature. No wonder why there are so many people failed to overcome this obstacle to improve their trading.

Be Honest With Yourself

To solve the first obstacle, you may have to solve an even bigger problem – being honest with yourself.

Since being honest with one self can be very difficult for some and that the only thing we are interested in is to improve our trading only, we can reduce the difficulty by being honest with ourselves in trading only.

Start with something simple. Criticize yourself on things that are obviously bad and difficult to deny. Write them down.

You need to crack your auto defense mechanism first with something minor and then move up the scale slowly. Once you are able to conduct self criticism in a constructive way, you will be able to identify more issues over time. The goal is to allow yourself to see better of what can be done to improve your trading.

There is no point to criticize yourself outside of trading because your interest is not to make yourself into a better person per se. I am not saying that is not a good thing. Just that I am not a "do no evil preacher" either.

For those interested in more about human behaviour in this aspect, you can watch the TED Talk by Dan Ariely, Our buggy moral code. It is a more thorough presentation on how we cheat and being dishonest in general. There are a lot of interesting topics he has touched in the presentation. At the end of the video, Mr. Ariely’s discussion on the difficulty for someone to accept the the opinions from other people when their intuition is contradictory to those opinions strikes home for many aspiring traders.

Kick Start Your Learning / Self-Correction Capability

To solve the obstacle of unable to correct our costly behaviour, there is a simple solution – keep learning new things.

As oppose to focus on just trading, which is the big hurdle you are facing, try doing something else that is simple yet challenging task. It can be a puzzle game. It can be building toy models. It can be learning new ideas and concepts from TED. The feedback from successfully acquiring new knowledge and insights from these tasks will make it easier for you to see the problems hidden within your current trade plan and also improve your willingness to adopt new strategies over the existing one that is not working for you.

It is a trick that triggers your mind to open up a little to different views. By giving it a small reward of satisfaction for adapting and learning new things, your mind is conditioned to be more acceptable to changes on your existing behaviours.

Do not, however, undertake another new challenge that is as complex as trading at the same time. It will defeat the purpose of stimulating your mind for the benefit of improving your trading. Having two daunting tasks instead of one can be very discouraging.

When Nothing Works There Is Always External Help

When you cannot see any problem in yourself or your trading game plan but you are struggling to become profitable, it means that you are not critical enough on yourself. It is probably best to seek for help from someone else. What you need desperately is an honest opinion on you and your strategy.

Due to the fact that the person who is going to help you will have to spend considerable amount of time to understand your situation and your game plan, a trading buddy may not be able to assist you. A coach or adviser with expertise in trading can be very costly and difficult to find as many of them are hired by trading firms to assist their in-house traders. If you do have the resources to hire a reputable coach, it is definitely something you can look into.

Going online and taking your issues to public forums may not be a good idea although you may get lucky at times. The disadvantage of taking your problem to a public trading forum is that people tend to pile on you as oppose to giving you constructive advices. There are also forum trolls who will do anything to seek attention and ruin your thread. If you are lucky, however, you may encounter some nice people who can point you to the right direction or people. Just do not put too much expectation in finding help from this route.

… end of the 4 part series

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November 24, 2012May 17, 2017

Essence of Trading: The Three Pillars of Critical Thinking (Part 3)

… continue from part 2

"Being ignorant is not so much a shame, as being unwilling to learn"

– Benjamin Franklin

Stop Associating Common Terms With Market Conditions Until You Can Understand What They Really Mean

The first most common mistake I have seen is that someone telling everybody that a stock (or whatever that thing is) is very cheap to buy and will go much higher. Yet, the word cheap is not defined clearly in the statement, nor the projection of going much higher is defined. The words cheap and going much higher is used casually without substance. At best they are just comforting sound bites.

Further investigations into this kind of claims usually result in the discovery that the person has already bought the stock. Digging deeper you will find out there is no proper money management (What? What is stop loss? Cheaper the better and I will buy more!) This risk of losing all the money throw at the stock may not be acceptable to that person but the possibility is never part of the consideration in the first place when the stock was bought.

Trading is not gambling if you choose wisely. If you like buying "cheap" stocks, figure out exactly what conditions are necessary to make a stock "cheap", something that will give you positive expectancies should you bet on that consistently. I use the word bet very carefully here. Bet in this context means you are not sure if the outcome will be in your favour but you know that because the exact conditions are met, you are likely going to make money off the bet. In another words, it is not gambling. You are similar to those people who count cards and (in the words of the casinos) loot the casinos consistently.

The big difference here is that casinos can ban you from placing your bets with them (usually after you extracted significant amount of money from their operations) while the regulated financial markets around the world cannot (most of the time).

Like Learning A New Language

Learn to stop speaking jargons to yourself until you have acceptable meanings for them. It is the very first step you can transform yourself to become more objective in evaluating the market conditions you are facing. Every time you find that you do not have an exact meaning to a term you use to describe the market, you have homework to do – write it down and investigate. All these accepted terminology without clear definition in your mind is an obstacle to your ability in handling the market you want to make money from.

This process of relearning the language you use on the markets is not easy. It is also not straightforward as you are filling in the gaps of your understanding of the markets, you will keep finding more holes in your knowledge of trading. It is normal that you feel overwhelmed in the beginning.

Remember that it is alright to not understand something because there may be nothing important to understand.

During your quest for clarification of your knowledge, some terms is simpler to learn because they are just definitions you have not heard of while some other ones will require your use of logic and statistic inference to define the concepts. It is the same as learning a foreign language. As your set of clarified concepts keep growing, you will be able to define and understand the more difficult ideas over time.

Clarity Comes From Rigorous Study

Some people will simply give up the approach as they could not do it without feeling uncomfortable. It is as if they are strip naked. It is exposing yourself to your own ignorant side. There is no need to resent this. Everyone have something they do not understand. No one is an expert in everything. Trading is very likely not your domain of knowledge or expertise because there is no such training from standardized education. There is no shame to accept this fact.

During this discovery (knowledge acquisition) period of the vague concepts in your mind, there are two common techniques to achieve the goal – direct and indirect approach to learning.

You can focus on using statistics on historical data and events to guide you. The collection of statistics and analysis through the lens of statistical method is an indirect learning experience, meaning that it requires acceptance of statistics as your ultimate decision making tool which is often difficult to do.

Knowing the subject of statistical analysis well has nothing to do with the ability to use it as a tool to acquire new knowledge. That is the reason why we see a lot of programmers and engineers who try their hands on trading and writing all these codes to study the markets, failed miserably in trading. They are just not the type of people who can accept new knowledge from indirect learning experience.

Personally I cannot solely rely on statistics results either. I always confirm the findings from both visual inspection of the new biases I obtained and also tracking them in real-time until I am comfortable to integrate them into my trading.

Direct learning experience means using hands on approach to learn new things. If it works better for you in the past, or it is how you learned your best skills, it is likely the better choice for you. For the purpose of trading, it translates into learning by rigorous visual inspection. First, you print out your charts, mark them with the important events, price patterns, etc. and then examine the charts or raw data closely. Bar by bar, one chart after another, you will start to feel natural with your interpretation of the information for each specific concept you have doubts about.

The clarification achieved through direct learning often cannot be quantified or explained exactly in words. You are just trained. It is very similar to our experience in learning to ride a bicycle or drive a car. We cannot explain how to do what we do exactly but we can do it.

There is no good or bad method to clarify your understanding of price actions in markets. Both methods I described above get the job done. Several of my mentors who highly specialized in specific trading methods (first techniques popped into my mind – point and figure, channel drawing) learned their chart reading methods the direct way. They have every single trading day of the markets they trade printed out with all kinds of notes, marking, etc. on their charts. When you treat trading seriously and understand your learning of chart reading is an important step towards your success in trading, you would do the same.

Notes: The discussion on Objective Evaluation went a bit longer than I expected as I have to cover various topics related to the mechanisms of learning. Hopefully I have explained the concepts clearly.
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