Poker Lessons for Option Traders

05/29/2013 8:00 am EST

Focus: OPTIONS

Price Headley

Founder and Chief Analyst, BigTrends.com

While the poker craze has died down quite a bit, there is still much to learn from this game of skill and luck that can apply to improve your trading, writes Price Headley of BigTrends.com.

Poker is not a pure skill game in the same way that chess and bridge are. That’s because there is much short-term luck in poker, whereas there is virtually no luck in chess and bridge. Still, you can’t help but notice that the same people cash winning tournament after tournament, enough to become almost household names. WSOP winner Chris Ferguson once said that “you don’t measure how well someone plays by his performance in one tournament, rather you judge him on how well he does over a year. Is he profitable?” Does that sound familiar? Sometimes, even investing geniuses like Warren Buffett buy stocks that tank in the short-term. But does it really matter? No, it’s the long haul that matters. That is, long-term profitability. Today, we will discuss systematic trading and avoiding the phenomenon of “tilt.”

Every Pro Has a System
Profitable poker players build a system (even multi-faceted ones with multiple approaches) and stick to it. So do profitable traders. There was once a TV reporter who asked a champion poker player what the secret is to winning so many hands. He answered that the object is not to win hands, but rather to make money. That being said, strong players play strong hands with few exceptions. They don’t get involved in hands that have a low probability of winning. Instead, they invest in hands that have a high probability of winning.

The point is that traders and players should stick to the situations that have a high probability of winning—get the probability ”edge” on your side. They should also remember that the object is to make the maximum amount of money—not the maximum number of trades. It sounds simple enough, but it’s not the whole picture—why would anyone change his system?

Lesson: Adhere to a precise, tested, winning system. Anything can happen in the short term. Stick with your system until long-term analysis determines a change is necessary.

“Tilt”
“Bob” is a very intelligent doctor who plays poker weekly at a local casino. He sticks to good strong hands and folds everything else. In fact, his system is very precise. He only plays two face cards, an ace and a high card, or a pair. The system worked like a charm for three months. Then one night, Bob threw away a 7-2, a terrible hand in Texas Hold’em. (This hand is the worst and should rarely be played, if ever.) Then, low and behold, the board came up 2-2-7, and Bob missed out on a full house! He started to go crazy! His head began to steam and his face grew hot! “Why did I throw that hand away?” he fumes. By the time the night was over, Bob abandoned his entire system that had made him thousands of dollars. He was convinced that his system was flawed and the game was all luck. The next three months were the worst of his poker career. He gave back the thousands he had earned and lost his mind as well.

This phenomenon also exists in trading. One thing that traders love to do is watch their trades after they exit. They want to be right so badly. They watch in horror as stocks skyrocket right after they sell, and begin to question the system that may have been working for them for years.

NEXT PAGE: 2 Lessons to Remember

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Have you ever shaken a pinball machine until it shut down? If not, you should know that if you pick up a pinball machine in the middle of play or if you kick it too hard with your knee, lights start flashing and the flippers stop working. The lights blink and you see the word “tilt” on the screen. That’s where the word tilt comes from in poker. It’s when a player loses control and shuts down like a pinball machine on tilt.

Getting angry at that moment is not what tilt is about though. It’s about what happens after a player goes on tilt. Oftentimes, a player will get a good hand like a king-high flush only to have it beaten on the “river” (the last card) by an ace-high flush. Many players describe that situation like this: “I feel my face getting hotter, and soon I feel numb.” Or, “I get very angry and start swearing.” Soon afterwards, the same players will be seen playing inferior hands that they would never play, or they might start bluffing too often. The bottom line is they can turn $10,000 worth of bad cards into a $100,000 loss. Is that possible? You’d better believe it is.

The amazing thing about tilt is this: it exists in every competitive field. It happens to basketball teams when they are losing and even when they are winning big. Have you ever seen your favorite team up by 20 at the half only to go on “tilt,” slack off, and lose the game? It happens all the time. Have you had a huge trade that paid off big time and then soon after made you felt like Superman and you started trading like a reckless maniac? Many traders have!

Control Your Emotions
Have you lost huge on a trade and started a month-long or year-long slump? Most traders have at least once. It all comes down to emotions! Recognize that there are times when you lose control and examine ways to avoid it. Better yet, when you recognize that you are on tilt, stop trading for a specific amount of time. I recommend not trading for the rest of the day at least, or depending on severity, maybe even the rest of the week.

A strong poker player once advised, “Do not judge yourself on how the hand turns out. Instead judge your actions. You have no control over what comes next. You should criticize your play if you play badly and the hand turns out a winner. You should praise your play if you play well and the hand turns out bad. This keeps you in focus on your system and helps you avoid “tilt.” It sounds philosophical and psychological, doesn’t it? It is! So, do the same when trading:

  • If you trade well, and an unforeseen global calamity drops the value of your portfolio and the market big time, relax. You can only do your best and no better. This will save you from a lot of mental blow-ups.

  • Also, don’t congratulate yourself when you make a trade mistake and it turns out profitable. That’s the worst thing you can do! This will cause you to question your system or revert to luck.

  • Do not express emotions when trading. That means no jumping out of your seat when you have a winning trade. Okay, you are allowed to grin, but that’s it! No cursing, crying, or hiding under your desk when you have a losing trade.

Can you believe poker teaches us about trading? It does, so don’t forget these two lessons when trading:

1. Operate by a system. Take note of it when you deviate from your system. Review your system at least quarterly.

2. Avoid “tilt” by keeping your cool when you trade and treat trading like a business. Focus on your actions and not short-term fluctuations (until your quarterly review).

Price Headley, Founder and Chief Analyst, BigTrends.com

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