On Stops, Sex, & Speculative Self-Destruction

Scorned speculators are scattered across the globe, tallying wins and losses, unable to recall the glamour of the halcyon days because they can’t stop thinking about that One. Tough. Beat.

In the opening scene of Rounders, poker player Mike McDermott (Matt Damon) loses his life savings in a single round of Texas Hold ’Em. His opponent turns over the cards, unearthing The Hand: aces full. Reeling, he quits the game and resolves to finish law school while driving a delivery truck for cash. But then his slimy snake of a best friend (Edward Norton) compels his return to the table. The friend incurs massive debt, the settlement for which McDermott assumes responsiblity. In dire straits, he borrows money from a professor and returns to the high stakes joint where he once fell short.

The scene is classic albeit clichéd cinema. Like Kirk Douglas in Spartacus or Mel Gibson in Braveheart, this speculator is heading for battle, armed only with a rubber band bank and a small-odds shot at redemption. The voiceover: “Jack King said, ‘Few players recall big pots they have won, strange as it seems, but every player can remember with remarkable accuracy the outstanding tough beats of his career.’ It seems true to me, cause walking in here, I can hardly remember how I built my bankroll, but I can’t stop thinking of how I lost it.” It’s Hollywood of course, and Damon’s character plays to perfection, dominating the man to whom he lost it all. He flips ten grand into sixty, pays off the debts, and he’s off to Vegas in pursuit of an even better draw on the river.

The film is one of my all time favorites, but it’s awful reinforcement. In portraying the improbable comeback of a gritty gambler in a bind, the movie glorifies the “all in” gambit on a weak flop – the same sort of speculative blunder that drowned Long-Term Capital Management, Lehman Brothers, and my liquid net worth at the roulette wheel last year. Doubling your bets until you’re bankrupt or until you’ve hit the table maximum – these are not proper strategies.

But it’s tough not to glorify. Niederhoffer’s book, The Education of a Speculator, opens with a tale about an overleveraged, weary and war-torn trader who’s long the yen. From down millions, the tape trends his way and he’s out with a big sum right before the rate tumbles – a swoon that would have wiped him out. “What a trade it was,” the awestruck operators opine.

One can imagine Niederhoffer writing the autobiographical anecdote inside his faux-alpine Connecticut mansion – safely ensconced in his home library, the walls littered with nineteenth-century American folk art, while sitting at his walnut desk, on which lie electic tomes on Galtian philosophy and yen-pound arbitrage — smiling smugly as he types, recalling his own deathly drawdowns, those ego-driven excesses he endured to emerge victorious, in speculation and in life.

A few years after the book hit the shelves, the tape turned — and Victor Niederhoffer blew up.

There’s a section in his book that’s telling. Niederhoffer says matter-of-factly: Never use stop losses. His argument is that the security invariably moves right to the level of the stop, forcing you out right before reversing wildly in the direction of the original bet. Admittedly, that can be true. Over the weekend I held a short position in Gamestop (GME). The stock gapped lower at the open Monday and then jumped down more. I was showing big profits on the screen. Wanting to protect my gains, I set my stop at about half of the profit sum. The stock rallied to exactly that level, stopping me out with a decent win, then it continued its southward momentum. Had I been on the bus for another hour, I’d have made a killing:

That sucks, right? Reminds me of this girl I liked as a college Freshman. She was older and more mature, cooler, and prettier than I. [She was smart too – but probably not smarter. I think that was my edge on the market.] Chance had it that we were in not one but two seminars together. The tape wanted me to prevail.

I had spent countless hours courting her to no avail. One night, I spent a week’s wages on her. We drank too much bourbon and things heated up. When the market opened, sobriety had set in. I was thrilled with my overnight trade. She was not. On the one hand, I could have taken my unexpected profits and praised my luck. Instead I brooded, lamenting my failure to maximize my investment and move in for the big score.

But you know what, that’s life. Not every loser can be a winner, and not every winner is going to be as lucrative as we would like, but that doesn’t mean we should place huge, unhedged levered bets – and it doesn’t mean we shouldn’t place orders to limit losses and protect gains.

Take the profits or the losses mandated by your stops and limits and walk away. Resist the urge to keep doubling down. Look for better odds via technical analysis of markets or middle school math. There’s an edge: playing single-zero European roulette in AC in lieu of American roulette in Vegas, for instance. Unless the game is rigged against us — or we miscue during the game — the jackpot will come. That’s the goal in this life, right?

Near the climactic scene in Rounders, the voiceover of the protagonist echoes: “I’ve often seen these people, these squares at the table, short stack and long odds against them. All their outs gone. One last card in the deck that can help them. I used to wonder how they could let themselves get into such bad shape, and how the hell they thought they could turn it around.” Don’t be that guy. Chances are you’ll blow up and find yourself auctioning off the family silver to pay for your naked puts on the S&P.

And as Brian Shannon from Alphatrends is wont to stress, don’t fall in love with anything that won’t love you back – not women, not stocks, not losing or winning stakes. The market is a cruel concubine, and she will never love you back. The whys and wherefores and what-ifs are of no use in this strained marriage. Take your profits as they come and cherish every victory. Cheers.