How advanced mathematics and gaming theory can help you as a trader
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If you read further than the headlines, you will find that this thread is not about game theory, but about gambling theory.
Now, as usual I disagree. Both game theory and gambling theory can be used to understand the behavior of market participants.
Game theory typically comes disguised as moral hazard. If you hear a CEO explaining: "We have to dance until the music stops playing", this is applied game theory. Repackaging mortgages and selling them as CDOs is indeed similar to a prisoner's dilemma situation and does represent a Nash equilibrium. So the big guys act along the lines of game theory, even if they don't know it. The same is true for the bonus payments, the sequence " I win, I win, I win, you (the public) lose" is another classic of game theory. Or take the beauty contest of Keynes.....
This was a small excursion from the original subject. @RM99 wanted to discuss the impact of progressive betting strategies. This belongs to money management and can indeed increase your returns, if used properly. There are several ways of progressive betting, but all of these will not yield anything if the expectancy is smaller than or equal to zero.
And obviously the big boys follow some money management rules, whatever they are.
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This was in Futures Magazine after the housing bubble burst....
Andrew Lahde, founder of Lahde Capital Management, a hedge fund that earned 870% in 2007 by shorting the type of mortgage backed toxic instruments that have left large institutions at the Fed's doorstep tin cup in hand announced his exit in October and thanked those who allowed his success: "The low hanging fruit, i.e., idiots whose parents paid for prep school, Yale, and then the Harvard MBA, were there for the taking. These people who were (often) truly not worthy of the education they received (or supposedly received) rose to the top of companies such as AIG, Bear Stearns, and Lehman Brothers and all levels of our government. All of this behavior supporting the Aristocracy only ended up making it easier for me to find people stupid enough to take the other side of my trades. God Bless America!"
I think they teach gaming theory in them math departments at them Ivy League schools...
I'm just a simple man trading a simple plan.
My daddy always said, "Every day above ground is a good day!"
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While game theory can be used to describe the crowding of the fools, its knowledge does not necessarily induce any change in Behavior.
Here is a clear conflict between social and monetary norms. The temptation to defect - term used in line with Axelrod's "The Evolution of Co-operation" is simply too large, so those guys cannot resist. Finally they did not care about the well-being of their employers, but just wanted to reap short-term bonus.
Moral Hazard is promoted by ignoring tail risks. And it is promoted by a prisoner's dilemma. This is the prisoners dilemma:
At your employer, most of your colleagues trade toxic instruments for short term bonuses. You know for sure, that in the end all the CDOs, CDSs will end up somewhere, so it is a game of musical chairs.
Option 1: You participate in the game. If it works out, everybody including you will get a bonus.
Option 2: You decide to do something reasonable, which will produce a lower yield, but has no tail risk.
Now let us look, whether you are better or worse off with option 2:
Scenario A: The toxic game continues, your employer makes a huge profit, your colleagues get a large bonusn and you get a small bonus.
Scenario B: The toxic game goes wrong, your employer loses a lot of money and nobody gets a bonus.
This shows that with option 2, doing something reasonable, you cannot win. This is actually a classical n-person prisoner's dilemma. It can only be overcome by repeating the game with the same participants many times. Social norms - which are always in conflict with unregulated markets - can by itself only be established, if the prisoner's dilemma occurs repeatedly.
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My 2 cents; let me know if I am missing the boat on this one I wont be offended. According to my wife I miss the boat a lot! lol
The one thing I don’t think these theories take into account is human perception, intuition and emotion. Many of them assume you bet on every single hand. This is not how real life works. Take the flip of the coin, if you bet on every single flip over a long period of time it would probably normalize and you end up somewhere around a 50/ 50 split. This is assuming you had zero emotions when betting. Now suppose you didn’t bet on every flip. What if you only bet when 3 heads in a row followed by a tails came up and even then you had the choice to bet or not to bet. Now throw emotion, intuition, perception and the confidence of the individual into it. This would change the odds and the outcome dramatically.
As the old saying goes you have to know when to hold them and know when to fold them. When playing roulette I only bet on black or red. Rarely if at all, do I bet on every single roll of the ball. I watch the numbers come up and look for a pattern. Its exactly the same as looking at a chart and waiting for a high probability set up. I see a cluster of numbers where I perceive to have a better chance of winning then I will bet on it. I also have confidence when I walk into a casino that I will not lose any money. Over time this has allowed me to come out ahead. The one thing about this process it can be very time consuming and some days there is very little opportunity, again this is just like trading.
I guess my point it is theory is great but how practical is it in real world applications?
SD
nosce te ipsum
You make your own opportunities in life.
The following user says Thank You to Silver Dragon for this post:
I'd agree with you totally. I am simming a scalping system(not one of my own design) and it uses small targets and larger stops.
The biggest factor in it's success is fills. Since it uses limit orders some you know for sure, would be filled, some a question mark.
Now gaming theory would suggest it's a loser, and if you took every trade all day, I have absolutely no doubt it would be, But.....
As traders we can use are trading knowledge to change that. First, there are times of day, the market is more liquid then others. Only trade then.
Second, the system will usually have 3 or 4 winners and then a loser. So take to trades and stop until there is a loser. That alone has a drastic effect on the results.
Third. Trade several markets. That way a loser can be offset.
Fourth This is the biggie. Set a very realistic profit goal for the day. I am using $75 per contract. When that is his, cancel orders, and shut it down.
Fifth. Different systems, may or may not work for an individual. Make sure the system fits you. Your belief system have a huge impact on results.
Pete
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You'd better not go into a casino. It is impossible to identify pattern with a roulette wheel, so you are going to lose money sooner or later. So your pattern recognition skills just lead you astray in this case and you make a fool. The only thing that can save you is sheer luck, as described by W.Somerset Maugham in his novel "The Facts of Life".
Seeing clusters in in numbers generated by a roulette wheel is a trap. Evolution has built our brain for pattern recognition and we even see pattern, where the are none. It is by far cheaper to count the little sheep in the sky than
Nota: There was at least one exception in history. One guy had the patience to record thousands of wheel runs for each of the roulette wheel in a casino and discovered that one of eight wheels was slightly uneven, which in turn increased the probability for the outcome of a specific number. This guy actually won a lot of money, before the casino exchanged the wheel. But you cannot make money from an even wheel in the longer run, as it is against the laws of probability.
This is an example where both psychology and money management cannot help you, as the odds are already against you, before you can make any further mistakes.
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This is not evident. You need to show first that the trades are negatively correlated. If not, you have simply become a victim to the Gambler's Fallacy.
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This would change the odds and the outcome dramatically? Only of your account, not the result of the coin toss. The coin doesn't care and has no memory.
The following 2 users say Thank You to MXASJ for this post:
I agree with @MXASJ. Emotions do not have an impact on the outcome. You may even elect not to play.
Your conclusion is just an example of the Gambler's Fallacy. It is simply false (sorry I sometimes enjoy being blunt, if it serves the purpose, please forgive me).
Emotions may have an impact on correlated bets, but your example is built on uncorrelated bets. All emotions, perceptions and confidence will not change the outcome, it will be simply random.
Roulette (fair wheel) also involves successive non-correlated bets, so emotions will not have an impact on the outcome either. However, you may increase your odds, not to lose money in Roulette:
-> best decision : not to play
-> second best decision: play only once and bet everything you have on black or red (winning probability 18/37 for European Roulette, losing probability 19/37)
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