 |
|
~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ 25 July 2007 Table of Contents (1) Quote on Poker (2) Article - How the Poker Craze Can Help You Trade by Chris Perruna (3) Website Update - Trading Interviews ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ RSS Feed Stay up to date with all that is happening at Trading Plan, by subscribing to our 'Trading Blog' (no email address necessary). I am continually adding content and every update of this site is announced here, including minor content updates, page additions, and product releases. So stay plugged in by subscribing to this site's RSS feed. Copy and paste the address below into your RSS reader to receive the Trading Plan RSS feed... http://www.trading-plan.com/Trading-Plan.xml Not sure what RSS is? ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ Previous Issues Only just joined the mailing list? That's OK - you can read all of the previous issues of the Trading-Plan ezine. Visit http://www.trading-plan.com/ezines_previous.html to access the archive. ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ Filtering software may prevent you from receiving Trading-Plancommunication, including my ezines. To ensure that you never missan e-mail from me, please follow these tips... http://www.trading-plan.com/whitelisting.html ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ Online Trading Forum Do you want to learn from the experiences of others in a friendly online trading forum? I now frequent and contribute to the online trading forum called Stock Meeting Place. Membership is easy and free. You can come along and ask any trading question in one of the numerous sections of the forum and receive a helpful response from one of the many members (approximately 2000). This forum is the only place online where you will also find Daryl Guppy, the well known trader and author. Remember, there is no such thing as a silly question so visit, sign up and ask a question. Visit http://www.trading-plan.com/trading_forum.html for more information. ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ -- 1 -- Quote on Poker “The strong point in poker is never to lose your temper, either with those you are playing with or, more particularly, with the cards. There is no sympathy in poker. Always keep cool. If you lose your head you will lose all your chips.” William J. Florence, from The Gentleman’s Handbook on Poker -- 2 -- Article - How the Poker Craze Can Help You Trade by Chris Perruna I have been trading my own accounts for about ten years and I continue to learn more with each passing day but 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 emotion balance and a 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 the game of 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 the game of poker and the game of trading but the average Joe would never understand 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. 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, no back testing or historical testing required in my opinion. Back testing may help but playing sports my whole life 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 needs to follow rules in order to preserve capital and cut losses. The traders must also consider the odds of their stock 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 when to make that bet based on the system’s expectancy should be the top priority. So where does system development start? By properly understanding position sizing techniques and calculated expectancies, 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 how much will be gained or lost during each trade over a period of time. Using this as one part of the equation, the investor 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. The word ‘algorithm’ may scare many people away but I have developed very simple position sizing and expectancy spreadsheets that can be found on my blog. They can be downloaded, studied and tweaked without any advanced mathematical experience. 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? ** We can determine how much to place on each trade by assuming a $100,000 account with 1% risk on each trade. Using a CANSLIM trading approach, I will place my stops approximately 8% below the ideal entry area or pivot point. $100,000 Account1% Risk = $1,0008% Stop LossPosition Size will be $12,500 We calculate the position size by dividing the 1% risk by the 8% stop loss or $1000 / 8% = $12,500. If the stock we are watching has an ideal entry of $50, we now know that we can buy 250 shares or $12,500 worth of stock. Our stop loss is $46 or 8% of $50 and our maximum loss is $1,000 of the original $100,000 portfolio. We can now start to develop system expectancy if we use this basic position sizing algorithm with every trade. ** What exactly is expectancy? ** Expectancy tells you what you can expect to make (win or lose) for every dollar risked. Casinos make money because the expectancy of every one of their games is in their favor. Play long enough and you are expected to lose and they are expected to win because the “odds” are in their favor. Most games at a casino are completed in a short period of time so they can increase their odds of winning. The only game that does not benefit the casino is poker because the game is played between individuals, not against the house. They do take a rake or a percentage of each pot so we will consider this commission fees. The same holds true for investing. If your expectancy is positive; you can make more money with multiple trades in shorter periods of time. If you told me this idea ten years ago, I would strongly disagree based solely on beliefs. Now with experience, I continue to move towards more frequent trading and a structured system that is run like a business. Expectancy is your profit percentage per win multiplied by your win rate minus your loss percentage per loss multiplied by your loss rate. I will use an example of Expectancy from Dr. Van Tharp: Expectancy = (Probability of Win * Average Win) - (Probability of Loss * Average Loss) Expectancy = (PW*AW) less (PL*AL)PW is the probability of winning and PL is the probability of losing.AW is the average gain (win) and AL is the average loss So let’s do an example using a CANSLIM approach (assume $12,500 per position, a $100,000 portfolio using 1% equity risk): If my trades are successful 40% of the time and I realize an average profit of 20% but I lose an average of 5%, my expectancy is $625 per trade. (0.4 * $2,500) - (0.6 * $625) =$1,000-$375 = $625 I lose 60% of the time yet I show a profit of $625 per trade. If I have a system that produces 65 trades per year, I would realize an annual gain of $40,625 (hypothetical scenario). A 40% gain on the original $100,000 (minus all commissions, fees, taxes and compounding). Let’s look at the calculation one more time using only percentages: PW: 40%AW: 20%PL: 60%AL: 5% (40% * 20%) - (60% * 5%) = 5.00% What this tells me is that I have a positive expectancy of 5% or $625 per trade from the original $12,500. It doesn’t mean that I will make $625 on every single trade but my system will average a profit of $625 per trade over the course of a year with a combination of winners and losers. I can always make more trades or fewer trades in a year so my total profit will be adjusted accordingly. With the basics of position sizing and expectancy explained, I would like to tell you why poker has made me a better trader. I will start by taking you through a game plan that has helped me use expectancies, emotion balance and position sizing to consistently win money at the tables. I will admit that I am not a high stakes poker player but I can hold my own when I feel comfortable with the amount of money that is risked in any one hand. As with investing, don’t over trade or trade more money than you are comfortable with. Tournament play is similar to options as a premium is paid up front in exchange for chips or the right to exercise those chips during a specific hand. As I sit and start to play, my first goal is to become familiar with the character traits of the players around me. Typically 9 or 10 players will be at the table so I will have plenty of time to evaluate the people I am playing with, without risking a great deal of money. After several rounds of play, I will be aware of the character traits of the people I am playing with and will understand that some players may be tight and only bet high odd hands. These players may typically be edgy and nervous and fold the cards with force as I have observed in the past. Other players may also play hands with high odds but will mix it up and call bets with cards that carry more risk along with lower odds. Every table has the quintessential bluffer that typically talks a big game, has a smirk on their face and sports a pair of dark glasses. This can be referred to as the present day “TV-type” player that wants to win the World Series of Poker on ESPN. These players are very similar to traders that buy late night trading systems from infomercials and lose most of their money by incorrectly trading the system or making impulse trades. They also remind me of the people that scour internet web forums looking for justifications on their trading ideas or they simply pump their own ideas without following basic rules. When playing poker, you must pay to gather information from certain types of players and this means calling a hand that you know may lose but the risk and money committed is minimal. Essentially, your overall position size relative to the pot odds justifies the call which allows you to make better or more informed decisions later in the game or tournament. The same holds true when trading. You may have a setup flashing on your screen so you take the trade but it quickly reverses so you close out the position. Don’t consider this a loss; consider this valuable information that warns you that the ideal entry is not now. Instead, you cut the loss while it is small and continue to monitor the situation so you can place another position if the ideal opportunity arrives in the future. You must pay for information in the trading and poker worlds; it will only make you understand the games better. While poker players are their own characters; stocks are made up of human character traits, similar to the type of people that trade them. Some stocks are risky and volatile while other stocks are conservative and predictable. The market repeats cycles and specific chart patterns because humans repeat their actions and character tendencies. By learning how to target character traits at the poker table, I have started to understand that certain stocks act in predictable ways because the people trading them can’t change their emotional make-up. Many poker players will make the same mistakes and place the same erratic bets no matter how much they try to play differently. Most stocks will act according to historical patterns and follow the trend no matter how much you think the chart will do otherwise. I won’t get into the exact rules of playing poker but I can tell you that only two players are required to bet per round while the other eight can view their first two cards without risking a cent. My game of choice is Texas Hold’em, the current craze across the globe and one that excites me when I am in the environment. The two players required to bet represent the big and small blinds. The dealer and all other player at the table can view the first two cards for free without a bet. If the hand is weak, you can fold and keep your gambling stake. Here is where it gets interesting; if I have a decent hand, I can decide to call the larger blind and see the next three cards on the flop, which is still a low risk investment. If the flop doesn’t provide me with the cards I need, I can immediately cut my losses short by folding and wait for the next game. The same is true in investing; I can cut a loss short and wait for the next opportunity without risking the farm if I realize an immediate loss. If the cards are good and my probabilities of winning the hand are high, I can call or raise the bet. When I place a trade and it shows a profit, my belief was correct and I will consider adding to the position. A fourth and fifth card (the turn and the river) are placed on the table after the flop and betting continues with each round. Again, I can decide if I would like to call, raise or cut my losses short. The connection I am trying to make with investing in the stock market and playing poker relates directly to cutting losses short (capital preservation and money management) and my odds of winning the game (in the stock market this is called expectancy as explain earlier). All investors and poker players bring emotions to the table, some people control them better while other people employ more efficient systems and understand the odds on a higher level. The bottom line is to understand the situation around you and to use a sound system to raise your odds. Never bet a hand that represents a low chance of winning and never ride a loss that could multiply overnight. Cut losses short and get out of the game and wait for the next opportunity because they are always around the corner. While watching the 2005 US Poker Championships on ESPN, a statistic caught my attention so I paused the show, wrote it down and thought to myself that it would serve as an excellent example on expectancy. Poker expectancy example (this relates directly to trading): Nine players at the table34 total hands were played in this round Player A saw the flop 28 of 34 hands or 82% of the timePlayer A won hands 16 out of 28 tries for a 57% winning percentage Player B saw the flop 11 of 34 hands or 32% of the timePlayer B won hands 4 out of 11 tries for a 36% winning percentage Looking at these numbers and assuming that both players had equal chips (they were close), who do you think made more money during the round? Most people would guess Player A due to the 57% winning percentage on 16 hands. Player B fails in comparison with only 4 wins, a quarter of the wins of Player A. Well, Player A actually had a net loss of 5,500 chips while Player B actually had a net gain of 10,000 chips. ** So what is my point? ** The point is that being more active or less active is not a way to guarantee success. You must formulate a positive expectancy system that balances the opportunities with minimal risk and maximum gain. Player B took on less opportunity but made the most of it when the opportunity arrived. Player A was erratic and played several hands that gave him poor odds and this is what I see so many traders do when the market is weak. They trade for the sake of trading and they lose. Traders must battle their patience and stick to their rules so they don’t trade erratically and play the game for the sake of playing. By playing poker, I have cemented my understanding of how people act, how to play the right odds, how to develop expectancies based on the cards I am dealt and how to position my trades properly. Watching these techniques and rules work within a short period of time really drove home the importance of a system that follows the proven rules. Trading can be a long, tedious and impatient road to travel but following the rules and employing proper position sizing and expectancy calculations will almost guarantee success if the rest of you system does it’s job. If your system is broke, find one that works and understand that you won’t go broke by properly placing your trades or bets and understanding how much you can and will win from each trade and/or bet. About Chris: Chris Perruna obtained his degree in Architecture and practiced in the field of Historic Preservation in NYC prior to joining a Fortune 500 Home Building Company listed on the NYSE. He invested in and studied the market while working as an architect but decided to pursue his dream and trade for a living and develop his own equity research firm. He has been trading his own accounts for ten years including stocks and options. Chris currently writes daily for his free blog, www.chrisperruna.com, and is the founder of www.MarketStockWatch.com -- 3 -- Website Update - Trading Interviews In the last couple of weeks, I have published some of the trading interviews that I have conducted over the last few months. They provide powerful insight into how others think about some critical issues to trading well. I trust you will enjoy them and learn from them. Please visit www.trading-plan.com/trading_interviews.html to access the index page. ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~
|
