Since I brought up gambling so many times in the last Philosophy post, I want to discuss “trading” vs “gambling.”  In our society, traders are considered one of the “top” professions in the world, and “gamblers” are considered one of the worst.  This has always been curious to me because the line separating the two is extremely thin.  There are traders who I would consider “gamblers”, and there are gamblers who I would consider excellent risk-takers.  In fact, one of the big producers on JPM trading desk (made $100 million per year almost every year) used to say that he would hire a top professional poker over an MBA any day.  Trading is all about assessing risk vs reward, positioning to maximize expected value and managing bankroll.  It turns out that if you are a good gambler, that’s what you do as well.  

I suspect that 80+% of individual traders are actually just “gamblers.”  It’s just a guess.  A lot of the things they probably enjoy about trading are the things they may enjoy about fantasy football or wagering at the casino.  There’s definitely an “entertainment” component to wagering on something.  But there’s a difference between participating in a “fun” March Madness bracket with your friends (where most of you are equally clueless), and doing it against a “professional.”  The pro actually looks at all angles, generates models of performance, runs backtests, looks at injury reports – basically makes use of most pieces of data available.  They may even have access to some non-public info, like what percentage of bettors are taking certain teams – or even what the other participants’ brackets look like.  Many of them can replicate the official betting lines (or do even better).  When you trade, you are going against an entire population of these “pros.”  So you need to have a firm grip on what you actually know vs what you think you know in a zero sum game.

There are three things that differentiate a “good trader” and a “bad gambler” in my mind:

  • Having a good sense of risk / reward.  In the last post I wrote, we covered the importance of having a good sense of the reward and risk.
  • Having good risk and bankroll management.  Once you have the trade idea, optimal execution would lead you to size, scale and manage the P&L accordingly.  And this is not just in isolation, but within the context of the other trades in your portfolio.  You also need to consider your risk limits, drawdown limits, company’s policies, company’s performance metrics, margin requirements, and investor requirements.
  • Having tilt control (aka spew control).  This is basically why “gamblers” have a bad reputation.  When things start going poorly, you need to have even more clarity to make good decisions.  However, for some/many, it is difficult to keep perspective and make the tough decisions.  So they throw more money at poor decisions and basically throw gasoline on the fire.  Try to develop the discipline to make good decisions all the time – especially when things are not going well.  A tactical retreat is going to let you fight many more days.

I may expand these topics further at some point, but I want to start moving towards strategy.