August 17, 2016

Making money with incomplete information

In poker, you have very limited information until the hand gets played out. In trading, you have the current value of the stock and option prices, but no real idea of what the market will do next. With partial information in both, the best way to put yourself in a position to win is by using the information provided to your advantage.

The similarities between the two are obvious from the beginning. When being dealt a hand at the poker table, a player is left with an immediate decision: call the present bet and continue playing, or fold and wait until the next hand. This choice, for the best players, should be a very mechanical one.

WITH EACH POSSIBLE HAND COMES A DIFFERENT SET OF PROBABILITIES

If a player is dealt pocket aces, he or she knows that there is an 85% chance (with two players) that they will win the hand. Alternatively, they know that if they are dealt pocket twos, their chances of winning are closer to 50%. With these probabilities ingrained in their mind, poker players can pick and choose which hands to continue playing, allowing them to select moments in the game that give them the best opportunity for success.

Traders have very similar mechanics when putting on a trade. When using options, traders have the ability to calculate their own probability of profit (the likelihood the trade will make at least $0.01).

A MECHANICAL MIND IS THE KEY

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