What Do Casinos, Bookies and Market Makers Have in Common?

Of casinos, bookies and market makers.

For the past 25 years I have been avid supporter of all three businesses – casinos, bookies and market makers. And by supporter, I mean my hard earned money has gone to support these businesses.

At some point it occurred to me that these business models are connected and that connection became the access to a breakthrough in my performance and profitability.

Let’s look at these business models:

CASINOS

Casinos make money because every game they offer has a built in statistical advantage for the casino. That edge can be very small (lower than two percent), but over time and the millions of bets placed by casino patrons, that edge earns the casino enough money to build elaborate hotels, fountains, giant pyramids, towers and replicas of famous landmarks.

BOOKIES

Generally, a bookie is an expert in the field in which he or she offers bets. Bookies have to be extremely knowledgeable, or they will not be able to turn a profit.

The goal of a bookie is to set up a point spread which allows him or her to profit no matter what the outcome of an event is. This requires a constant adjustment of the odds, and in some cases a bookie may even buy bets from another bookie to create a desired spread.

MARKET MAKERS:

Ever think about how you can just call your broker (or go online) and in a moment’s notice sell 1,000 shares of Cisco? I mean, who is buying those shares? How does that really work?

Well, a market maker is to thank for this. There are people, market makers, that are willing to be there, standing by at all times, to buy or promise to sell any given stock. They will buy whatever you are selling, or they will go out and get whatever you want to buy. They are the grease in the wheels of the market.

What is interesting, from our perspective, is HOW MARKET MAKERS MAKE THEIR MONEY!

Look, they are taking a risk with every trade. Suppose they buy your 1,000 shares of Cisco that you want to dump and before they can sell it the price drops? They are risking their assets with every trade they facilitate.

How they counter this, how they profit, is they add a little something to every trade. They buy for a little less than the current price and the sell for a few cents more than the going rate. They don’t need a lot of mark up. Just a few pennies on either side – but given the volume of what they do, they wind up ahead.

Not only is their risk mitigated, but the amount they add puts the odds on their side. They are not playing for the stock to rise or fall at all. They just want there to be volume!

THE MILLION DOLLAR CONNECTION

Can you see it? All three make their money by guaranteeing that THEY have the statistical advantage at all times.

None of them need to (or look to) win big. No, their money comes from the EDGE that they establish BEFORE any bets are placed. In fact, they are the ones

TAKING the bets, not MAKING the bets.

All they need is a small edge and they know, mathematically that they are going to come out ahead.

So what of it? Good for them. What does that have to do with us?

Well, what if I told you there was a way to gain the same statistical advantage that casinos, bookies and market makers have? What if I told you that there was a way for you to stop MAKING trades and start TAKING trades (just like a casino, bookie and market maker)?

I want you to know that there is. You can trade like a bookie. You can trade like a casino. You can use market makers to be a market maker.

Poker and the Stock Market

I was out of town this weekend in Southern NJ, Atlantic City to be exact. After finishing my business at the convention center, I traveled back to the newest casino, the Borgata where I was staying for the night. I don’t consider myself a gambler and have never enjoyed losing money at the tables. When I do gamble, my preferred games have always been craps and blackjack. Until recently, I had never played at a poker table in a casino environment but I enjoy the game of poker and have only played in backyard and basement games with old buddies. Many people consider the game of poker pure luck but this is not an accurate observation. Many factors run parallel with the game of poker and the game of stock market investing. Luck may play a part but rules, odds and money management are the largest components of the two entities.

When investing in the stock market, it is essential to have a sound set of rules or a system that has been tested in real time, no back testing or historical testing needed. After the system has been tested, the investor needs to follow rules in order to preserve capital and cut losses. The investor must also consider the odds of his/her stock making a gain or making a loss. Price objectives and targets should be a large part of every investor’s system. With proper money management and calculated expectancy, the investor should aim to trade only in situations where the odds are in his/her favor. In a strong bull market, it may not be wise to start shorting many stocks; the odds of making a big gain with this strategy could be very low. Another major component that works its way into investing is psychology and/or human emotion. Stocks are made up of human character traits, similar to the type of people that own them. Some stocks are risky and volatile while other stocks are conservative and predictable. The market repeats cycles and specific chart patterns because humans repeat their actions and character tendencies.

Now, back to the poker table; as I sat down and started to play, my first goal was to become familiar with the character traits of the players around me. With 10 players at the table, I had plenty of time to evaluate the people I was playing with, without risking a great deal of money. After several rounds of play, I was aware that the gentleman to my right would only bet high odd hands and would fold every other hand. He was very edgy and nervous and folded his cards with force when he was angry. The gentleman to the left would also play hands with high odds but I did see him call bets with some hands that were risky with lower odds. One gentleman across the table was the bluffer and always had a smirk on his face with a pair of dark glasses. I challenged this man on several occasions and paid to see his cards because I felt he had nothing. More times than not, I was right and still beat him with an average hand. I could go on but you understand the point I am trying to make: all poker players and investors bring their emotions to the table.

I won’t get into the exact rules of playing poker but I can tell you that only two players are required to bet per round while the other eight can view their first two cards without risking a cent. My game of choice is Texas Hold’em, the current craze across the country and one that excites me when I am in the environment. The two players required to bet represent the big and small blinds. If you are the dealer or anoy other players at the table, you can view your first two cards for free without an bet. If the hand is weak, you can fold and keep your gambling stake.

Here is where it gets interesting; if I have a decent hand, I can decide to call the larger blind and see the next three cards on the flop, which is still a low risk investment. If the flop doesn’t provide me with the cards I need, I can immediately cut my losses short by folding and wait for the next game. The same is true in investing; I can cut a loss short and wait for the next opportunity without risking the farm if I realize an immediate loss. If the cards are good and my probabilities of winning the hand are high, I can call the bet or raise the bet. A fourth and fifth card (the turn and the river) are placed on the table after the flop and betting continues with each round. Again, I can decide if I would like to call, raise or cut my losses short. The connection I am trying to make with investing in the stock market and playing poker relates directly to cutting losses short (capital preservation and money management) and my odds of winning the game (in the stock market this could be called expectancy).

In my opinion, the best game to play at the casino is $1-$2 no limit style. This means that the blinds are held to a minimum and it will only cost you a couple of dollars to see the flop in many cases. The “no-limit” aspect allows your upside potential to be unlimited which carries through to investing. If you cut losses short and ride your winner, the up-side potential in investing can also be unlimited, especially when using options (but that is for another discussion). Last night, I could see my first two cards for free, eight out of every ten hands and I could fold if they were no good. If they were good, I put money on the table after my idea. In the real world, the world of stock investing, you should always put money after your best ideas. The ensuing gain or loss will tell you if you are right. Again, for the umpteenth time in this article, the most important part of both games is cutting losses short and moving on without mixing emotions into the decisions.

All investors and poker players bring emotions to the table, some people control them better while other people employ better systems and understand the odds on a higher level. The bottom line is to understand the situation around you and to use a sound system to raise your odds. Never bet a hand that represents a low chance of winning and never ride a loss that could multiply overnight. Cut losses short and get out of the game and wait for the next opportunity because they are always around the corner.