Trading and investing draw distinct comparisons to blackjack and poker, all three are situations of uncertainty in which your success depends upon you putting the odds in your favor. There are no sure things, outside of cheating (insider trading, collusion with the card dealer, etc), and losses cannot be avoided.
Players of markets, blackjack, and poker also realize that they as humans are fundamentally flawed at making optimal decisions on the fly, so they devise systems. If X happens, do Y. It can get as complex as OTC swaps market making algorithms, to as simple as following an expected value chart in poker to choose your starting hands.
The main similarity between these card games and financial markets is making decisions with incomplete information. In face of this, the only two choices one has to play out an edge is using discretionary knowledge built over years of experience, or devising a system that will have an edge over statistical randomness.
Mathematical Poker Player
The analogy between successful poker playing and trading financial markets is one often made, both by poker players and traders. The skillsets of making decisions based on incomplete information and money management is so similar that hedge funds often recruit professional poker players to teach them to trade at their firm.
A trader managing money has to make sure he doesn’t lose a significant amount of his capital on any given trade. Because all trades have a high degree of uncertainty, risking something like 50% of your capital on one trade because you have a high degree of conviction, can lead to ruin for a trader. The same stands true in poker. Trading in markets and playing poker both contain a great degree of variance, meaning even with optimal play/trading, sometimes you will go on a losing streak. It’s important to only risk a small portion of your trading account/bankroll because of this. Many poker players will only use something like 5% of their bankroll for one buy-in to a cash
I like to compare the selection of starting hands in poker to stock screening and stock selection for traders. Poker players know that at a full table of nine people, they will fold the majority of their starting hands, because of their expected value. Playing a hand like 7-2 offsuit (two different suits, like a 7 of clubs and 2 of diamonds) when four people are in the pot is a negative expected value play in the long run. Sometimes you will flop two pairs or three of a kind, but play that hand 1,000 times and you will lose money.
Similarly, a stock trader deploying a momentum strategy may get lucky once in a while when they buy a stock that is trading sideways and it shoots up, but do that 1,000 times instead of buying stocks according to your momentum criteria, and you will invariably lose money.
The situation poker players often find themselves in is when they know that their hand is probably beat, but the bet their opponent made gives them the proper odds to call the bet. For example, the pot has $1,000 in it, and you have the bottom pair on the board. Your opponent bets $100 on the river (the last round of betting). Due to your opponents behavior during the hand, you think his hand is probably better than yours, however, you have 9-to-1 odds to win the pot, so it’s worth your money to call the bet. Your opponent will be bluffing often enough for you to be profitable on that bet over time.
In markets, the same principle of pot odds apply for unlikely bets like out-of-the-money options. For example, one may think there’s a good chance of Tesla Motors going bankrupt, so you buy 24 month to expiration super out-of-the-money puts on the company for extremely cheap. While the market judges it as unlikely that Tesla will be bankrupt within two years, if the bets pays off, you will have earned many multiples on your money.
The Blackjack Card Counter
The blackjack card counter draws similarities to traders in a higher-level sense. I like to think of the regular game of blackjack without card counting as the market. In a casino game of blackjack, the house puts the odds in their favor, in markets, the “house,” or large institutions have an edge over the rest of the market participants. They underwrote many of the companies, have close contacts with the executives, have intimate knowledge of companies, and have enough capital to move markets and manipulate options markets. There have even been allegations of VIX options manipulation.
In order to combat “the house,” one has to deploy a systematic approach. Blackjack players count the cards and bet large when the remaining cards in the deck give them favorable odds, and bet small when the remaining cards do not bode well for them. Traders do much of the same. They develop a system to combat their emotions and market noise, something like a fundamental stock picking strategy like buying companies with cheap valuations, or a momentum strategy that buys high flying uptrending stocks, with little to no regard for the trader’s personal emotions.
As mentioned earlier, there’s a reason hedge funds prefer to develop professional card players to trade their capital, the players already have an intimate knowledge of applying statistics and keeping their emotions in check in the face of uncertainty. Traders looking to become more detached from their individual trades should try playing blackjack and applying something like Ed Thorp’s 10-count. Traders looking to optimize their decision making skills and game theory should look to poker games like Texas Hold’em.