If you want to undermine investing, you refer to it as gambling. Risk Of Ruin is a podcast that talks about how you can gamble without gambling. It is all about positive expected value and edges. I love the podcast and I particularly loved the last episode called “You Can’t Beat The Lottery”.
It is the story about a guy who beat the lottery. Can you believe it? In reality, it is way more than that. The story is the best way to put into a real life context rules and lessons valuable for wanna-be traders. This summer, I wrote about charlatans that sell online courses about trading. I found this conversation a great, alternative way to present the same concepts (or a gigantic confirmation-bias trap, you decide). Instead of reading this post, you should go and listen to the episode; you should actually listen to all the episodes before coming back here 😉
I have grouped and highlighted parts of the conversation and will provide my comments. The protagonist of the episode, Mr Doppy, is like a Marvel superhero: he had a disorder, stuttering, that eventually turned into a superpower. He is part of what is called the Advanced Players community, a group of “gamblers”, like card counters, who wants to beat the house in a systematic, non luck-based fashion.
The Source of Alpha
“promotions have to be beatable, scalable and don’t have to require a ton of money”
“marketing ideas that are exploitable loopholes”
Casinos design games by tilting odds in their favour so that they can make profits in a reliable manner. But the game design has to entice enough customers to play, otherwise the casino would make no profits at all. For this reasons, casinos sometimes offer promotions that alter the game odds in favour of the player, to lure enough folks in with the hope that they will be hooked even when the rules would revert back to the original odds. Advanced Players aim to find and play games only when the odds are in their favour (the “marketing ideas / promotions” above).
The Search for Alpha
“a decent, alternative name for this series [Risk of Ruin] would be Pay Attention. Just be observant”
“he and his friends refused to make any assumptions about the game and that’s where they ended up finding the value. So: do the work”
Many of us know that the odds in any lottery are in favour of the house, and by a large amount. So, many of us stop paying attention. It makes sense: time is a scarce resource, why wasting it checking something that we know is a sucker product?
It is very easy to move from “these are the odds of this lottery and they are not favourable” to the shortcut “lottery is a tax on stupidity”. To the point that even when the odds shift in our favour, we do not see it. In order to find value, you have to do the work.
“This thing was the opposite of glamourous”
In order to find value, you have to do a type of work that no one else wants to do. It cannot be pleasant, glamorous if you want, otherwise the space would be already saturated.
I cannot recall how many times I tried to explain a related concept to my wife, every time she wanted to launch a fashion project: it is harder than a standard entrepreneurship endeavour (which already have odds tilted against you) because there are many players that engage in the space that accept to be in a loss, just being part of it is enough for them (think how many wife-of, daughter-of launched fashion brands). Standard gamblers gamble for the emotions, the adrenaline, the rush…and then they fool themselves thinking they would be successful.
“people do not understand the difference between playing with an advantage and playing with a disadvantage. Things like expected value and variance aren’t super straight forward”
Paying attention is necessary but not sufficient. You need to be able to recognise value when you see it. You can acquire this ability by studying and learning: again, an activity that for most people is not pleasant.
The Exploitation of Alpha
“you just have to think about the incentives of all the people in the system that might alter you ability to do this play at scale”
“All the work is in the optimisation”
Finding an alpha opportunity is only the first step; since they are so rare and your time is finite (APs refers to this aspect in terms of “hourly rates”, if I remember correctly), you want to extract the max possible value out of it. Optimising the process becomes crucial: it is a quantitative (reducing frictions and costs) but also qualitative (dealing with people) matter.
It reminds me the hacker stories I read as a teenager: social engineering (the people aspect) is as important as code bugs for hackers. In finance, you have a spectrum of opportunities that goes from HFT, almost 100% quantitative, to insider trading, almost 100% social engineering.
“you need to have skills to understand how the whole system operates”
You have to learn how the piping works; details are extremely important at this stage. This is even less glamourous than the process to learn about EV and variance; while that knowledge is transferrable to the next exploit, this knowledge would be useless the moment alpha (in this case, the marketing promotion) disappears. See that the pancake stack of unpleasantries grows and grows.
[Please do not forget that at the end of this road of pain there should be a trading champion charlatan that willingly decides to renounce to a slice of their profits to offer you the fruit of their hard work for just $479. Sure.]
The skills required to identify the opportunity and the ones to understand and optimise the process are not necessarily the same. This might be one of the best explanation on why some opportunities are out there: you need a specific combination of people to act on them.
“Eventually you run into the problem of getting the entire bankroll in play -> figure out how much you can bet every day”
Each alpha opportunity eventually run into a capacity issue; the issue is directly related to the opportunity rate of return, since the faster you compound your gains, the faster you reach the capacity threshold.
I found an article about Proprietary Trading that covers some of the same aspects described by Mr Doppy. For example, here a passage on capacity issues:
“Shorter-horizon investment strategies are desirable because they tend to create higher Sharpe ratios. If your average holding period is a day or a month, you have the opportunity to place many more bets than if you hold positions for three months to a year or longer. On the flip side, shorter horizon strategies tend to have capacity issues (it’s easy to make a small amount of money with them, but harder to make a lot of money). Shorter horizon strategies also require serious investments in trading infrastructure, since quick and inexpensive execution is much more important than for longer horizon strategies.”
“if this thing went viral, we would have been paid prorated”
Another aspect of the capacity issue. When dealing with lotteries, you want to be the one AND THE ONLY ONE who holds the winning ticket. Otherwise you have to split the prize while your costs remain the same.
In the Proprietary Trading world, the capacity issue can also manifest in unintuitive ways: “As I increase the money invested in a strategy, my expected transaction costs increase while my pre-transaction cost estimate of expected return stays constant. Once my marginal expected return, net of transaction costs, crosses zero, increased investment in a strategy only loses money.”
The Curse
“he wanted the grind, he wanted something to focus his attention”
Listening to this, Ed Thorpe came to my mind. Lads that are able to find these opportunities have similar characteristics. It has to be something more powerful than greed and the desire to become rich. Wealth is the external manifestation of being right.
There is a fundamental difference between going out and shout to the World that you are a smart ass and do the same while selling a course. There is a fundamental difference between “oh, Ed Thorpe wrote a book” and “oh, Robert Kiyosaki wrote a book”.
“the hero of the story has to figure out what to do in the rest of his life”. “I had a license to print money, so when it ends, it is really difficult to accept a [normal job]. That sense of entitlement works your brain.”
Is there a better way to explain that this is just another form of entrepreneurship?
Can you teach creativity? You can provide best practices, a chronicle of what worked in the past and why. But you cannot assure anyone that they will write the next Catcher in the rye.
If you accept that trading, the exploitation of non-permanent alpha opportunities, is a form of entrepreneurship then the only thing that can be taught is a framework to minimise the probability of ruin, the deletion of path of certain failure. Which is fundamentally different from guaranteeing success.
“I found this one thing, one time and now I have to find something else and I cannot really enjoy the money because what happens if I never find the next thing. I have to protect this thing”
“I am not spending this amount of money, I am not enjoying the fruits of what I am doing because in some ways I do not feel I have earned them. My problems cannot be solved by those things. I am still the same guy”
This is really intense and authentic. Later, I will talk about the truthfulness of this and other similar stories. Even if it is bogus, there are still valuable elements like this one.
It is the Cassandra curse: even if you are right, no one will believe you. Not even yourself. The grind is the most unpleasant stage and yet is also the stage where you forget about your problems; the grind channel your attention away from your problems.
“gambling has given me a lot of freedom in my life, that’s the most important thing. Freedom to travel and to meet people. I found my people in the AP community. I found a way to do things on my own terms.”
This is the same guy that said he was not enjoying the fruit of what he was doing 😊 Our brain is a phenomenal thing. I just wanted to put both statements close to emphasis the contrast and yet their truthfulness.
“if you think about a normal job, there are many situation where it is pretty helpful that people overesetimate your abilities. In gambling, there are many situations where it is helpful if people underestimate you”
“all I wanted was to be respected, then I found this job which is basically social engineering the casino and the entire goal is to make sure that they do not respect you and your intelligence”
Another great contrast. It is not about if there are situations where playing dumb may provide value but the realisation that many people would not accept to play dumb even if they are promised money at the end of the road. Their ego would never allow them.
Information Sharing
“we all benefit from information sharing, the most successful gamblers work with other successful gamblers. what is the line where sharing information is good and sharing is bad. what I would say is that risk is like energy, it cannot be created or destroyed, it can only be transferred. If I don’t share this, I cannot expand my network, meet sharp people that can help me make more money. what’s the EV of talking about something even very vaguely vs the EV of being quiet. They are all risks that I try to manage. I benefitted from podcasts and it would be great if I can contribute with a story. There is a sense of community even if we are all competing against each others.“
There is the possibility that Mr Doppy story is 100% bullshit. There is no public ledger where we can check who won which lottery and when. We can only rely on the Risk of Ruin host to do his homework; but the host himself has a direct stake in this as well. If there are no more “Mr Doppy-like” stories out there, there is no more Risk of Ruin podcast.
The latest book in the infamous Market Wizard series by Jack Swagger is called Unknown Market Wizards. The idea behind the book is really compelling: are out there traders unknown to the big public that made spectacular returns? To make the idea work, you need those guys to exist. Jack Swagger HIMSELF said that he did not check the performances of the guys he interviewed for the book (plus the whole thing might be just a marketing stunt to upsell his company that certifies solo-trader performances).
Where is your Michael Lewis now? 😉
My point is twofold:
- Mr Doppy has for sure something to sell to other APs (he admits it!) and the host of the podcast might too…to you. Clear eyes, [full hearts] can’t lose. So keep your eyes open all the time.
- If you have to buy something from someone, be sure that the “authority” they are selling you is real. Trading competitions are BS. YT videos are BS. The Big4 certified fraudulent account in countless of cases, so not even third party statements can be fully trusted. Madoff got exposed after decades, so not even an extensive track record can be trusted. You need a combination of elements…and a valid reply to the fundamental question: why is this guy selling ME this?
The proprietary Trading article has a nice spin on this too.
“If your investment firm has a marketing department, you’re probably not that good an investor.”
Now quantify the marketing effort made by the guy who’s trying to sell you that trading course and you would get, reversed, how much value you can get out of it.
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