In this series we’ve considered various ways the strategies employed by those who invest in the stock market resemble those used by poker players. We’ve discussed the importance of timing in both contexts, parallels between studying the stock market and learning poker, how the psychological challenges of both can be similar, and how it is important to be able to measure and manage risk whether trading chips or stocks.
Today we’ll conclude this discussion with a look at how smart, sharp-eyed traders — much like intelligent poker players — use patience and observational skills to improve their chances of success. Not only do these astute investors spend time studying the market before committing to buy or sell stocks, but they study other investors, too, not unlike the way winning poker players put a lot of effort into watching what their opponents are doing.
Not long ago TradingHD contributor Mark Chapman wrote an article with a headline asking the reader Are you a reactive or passive trader? Those adjectives have a specific connotations in the context of trading that differ somewhat from how we might use them in poker.
A “reactive” trader, Chapman explains, is one who “typically buys or sells retracements in price and breakouts, and take trades off support and resistance.” That is to say, as the description suggests, reactive traders are apt to pull the trigger quickly and buy or sell stocks just as prices start to move, reacting to the market and not necessarily spending long periods studying their histories beforehand.
Meanwhile a “passive” trader “will watch and wait for price to unfold,” says Chapman, taking time to “observe the common trading patterns” before deciding how to act. “Passive” is sometimes used pejoratively in poker to describe non-aggresive players who check and fold too much, but here the term is more positively used to describe a thoughtful investor willing to put in the work of study and research, buying and selling with a lot more deliberation and knowledge.
Reactive traders can sometimes succeed, but in truth they are playing a game with much higher “variance” than are passive traders. As Chapman explains the reactive trader often runs the risk of getting unreasonably drawn into trading positions on the basis of relatively little evidence. A price movement will catch such an investor’s eye who promptly jumps on a stock, then the price will suddenly reverse and what seemed a sure quick hit quickly becomes a losing proposition.
Interestingly, a lot of reactive traders tend to make their moves based on certain recommended formulas. For example, certain retail traders — a subset of reactive traders discussed by Chapman — “tend to be very technically driven,” meaning “they do not really pay attention to other forms of analysis” and react similarly in response to specific, often-exhibited market patterns.
In poker, we might think of a no-limit hold’em player who open-raises before the flop and gets one caller, then without fail makes a continuation bet regardless of position, board texture, the opponent’s strength as a player or playing style, or other factors. The c-bet for this player can be likened to a reactive investor who always “fires” in the same way in response to the same set of circumstances.
When an observant player notices an opponent exhibiting this kind of pattern, he or she will patiently look for a spot to exploit it, perhaps checking a hand that connects well with the flop in order to let the chronic c-bettor make that bet (as always), then either check-raising to win the pot or calling as part of a strategy to extract even more value on subsequent streets.
Interestingly, Chapman goes on to talk about how passive traders can similarly take advantage of reactive traders. “Essentially, we watch several trading patterns commonly used by reactive technical traders to extract consistent trading profits from the markets day to day,” he explains, referring to the “passive” approach he and his students take.
Just as in poker we talk about “trapping” a player like the habitual c-bettor, so, too, does Chapman describe the strategy of exploiting reactive traders as the “Trapped Traders™ concept.”
For more about reactive and passive traders and other investment strategies potentially relevant to poker players, visit TradingHD.