If you ever wondered how a casino “prints money” consistently, then this post is for you.
- The most powerful thing a casino has over the players and what it means for your trading
- The most important number in your trading and why it matters (hint: it’s not your P&L)
- Why Warren Buffet can never bankrupt a casino even if he wants to—and how you can use this technique and make your trading account bankrupt-proof
- The secret to generating consistent profits like a casino
- How casinos adapt to changing market conditions (and how you can too)
Then let’s get started…
The most powerful thing a casino has at its disposal
There’s a special coin in your hands.
Every time it comes up heads, you win $2. And every time it comes up tails, I win $1.
Now in the long run, who will win?
You, of course! Because you have a mathematical edge over me.
And it doesn’t matter whether you’re gambling at a casino, betting on horses, or trading the financial markets.
If you want to make money from speculation, you must have an edge over the other players (or the house).
But what about risk management and trading psychology?
It matters, but not as much as you think.
Because without an edge in the markets, even the best risk management or trading psychology won’t save your account.
And this brings me to my next point…
You must know your numbers (it’s so easy that even a 10-year old can compute it)
Now, your edge can be expressed using this formula…
(Average gain x winning rate) – (Average loss x losing rate) – Transaction cost
And if you get a positive number, it means you have an edge in the markets (otherwise known as a positive expectancy).
Here’s an example, let’s say you have a trading system with the following metrics…
- Winning rate = 60%
- Losing rate = 40%
- Average gain = $500
- Average loss = $400
- Transaction cost = $10
So, plug in the numbers into the formula and you get…
(500 * 0.6) – (400 * 0.4) – $10 = $130
In other words, you can expect to make an average of $130 per trade (in the long run).
Does it make sense?
Because once you have a well-defined edge, it puts you ahead of 99% of retail traders — and that gives you the confidence to take things to the next level.
Why Warren Buffet can never bankrupt a casino (even if he wants to)
Warren Buffet, the greatest investor of all time, is worth USD 67.7 billion (as of this writing).
Now, let’s assume that Warren Buffet has turned evil and wants to bankrupt all casinos.
He plans to play Blackjack with the casinos and bet $5 billion on each hand. If he wins, he can easily bankrupt all casinos.
But that will never happen.
Because every casino in the world has a table limit. This means there’s a maximum amount to how much a player can wager on every bet.
You’re probably thinking:
“Isn’t it better to let the players bet as much as they want since the house has an edge over the players?”
Yes, in the long run, the house always wins. But, in the short run, anything can happen (it’s not surprising to see a casino lose 5, 10, or 20 bets in a row).
That’s why every casino sets a table limit to how much a player can bet. That’s their risk management put in place so that a losing streak will not end their business.
And this is the same for trading!
You must manage your risk like a casino so that even a losing streak doesn’t blow up your trading account.
The secret to generating consistent profits like a casino
Here’s the thing:
Every casino in the world has an edge over the players.
But, why are some casinos more profitable than others? And why do some casinos even go bankrupt?
On the surface, it seems like all you need is a statistical advantage over the players for you to mint money.
But, that’s only one small part of the equation.
You must also figure out how to…
- Attract new customers from competitors
- Retain existing customers
- Incentivize customers to spend more
- Keep your customers happy
Clearly, there are a lot of moving parts and one person can’t manage everything.
So, how does a casino do it?
The secret is this…
A casino has systems for everything they do.
#1: A casino has a system in place to incentivize their best customers to come back often by offering perks like free accommodations, transport, etc.
#2: All dealers follow a systematic way of playing Blackjack so the casino can consistently increase their revenue (and not leave it to the discretion of a dealer).
Now you might not be running a casino but, you’re managing your own trading business.
So, how do you manage it like a casino?
Well, you must have systems in place.
Risk management to ensure you don’t lose everything on a single trade.
Source of funds so you can pump in more money to your account and scale up your trading business.
Trading strategy so you have a fixed approach to enter & exit your trades — which improves your consistency.
Research & development so you can build new trading strategies and profit in different market conditions.
In other words, if you want a sustainable trading business that generates consistent profits, then you must have systems in place so your actions are consistent.
How casinos adapt to changing market conditions
Back in the 80s, it was easy to make money as a casino because there’s little to no competition.
Then, competition stepped in as more casinos entered the business. And the players got “smarter”.
At this point, market conditions have changed.
And if a casino refuses to adapt to changing market conditions, it’ll go out of business.
So what happened?
Casinos “levelled-up” and offered better services — free accommodation, free transport, VIP treatment, etc. Those that didn’t adapt went out of business.
And this is the same for trading.
Market conditions change and you must adapt to it.
If your trading strategy only makes money in an uptrend, then do you have a plan when it goes into a bear market?
If your trading strategy only makes money in a range market, then what happens when it breaks out and starts trending?
Before you trade any strategy, backtest it to make sure it can survive different market conditions (like uptrend, downtrend, recession, etc.)
This gives you confidence that your trading strategy is robust and able to withstand different market conditions.
Anticipate the worst and prepare for it, here’s how…
According to a study by Cesilla Horváth and Richard Paap, they found that casinos’ revenue was correlated with economic growth.
This means during a recession, a casino’s business will be negatively affected as fewer people visit the casinos.
So, what do they do?
Well, they could…
Reduce the number of staff to reduce their expense since they have fewer customers to serve.
Offer free rooms to attract customers back to the gambling tables so they can increase their revenue.
Improve the efficiency of their operation so they can lower expense and still maintain or even increase revenue.
Now if a casino can anticipate the worst and have contingency plans ready, they are likely to survive whatever comes their way.
Now what about your trading business, do you have contingency plans for it?
Here are some real issues you must consider…
- If you’re in a losing streak, can you still meet your day to day expenses?
- What if your broker goes belly up, how will that affect you?
- If your trading system goes into a drawdown, how do you know if you should continue trading it or stop altogether?
- If the markets suddenly collapse 10%, can you survive?
If you can answer these questions, then you have a sound trading business.
So here’s what you’ve learned today:
- Just like a casino, you must have an edge in the markets or else even having the best risk management can’t save you
- Once you have an edge, then your risk management comes into play because you don’t want to blow up your account over a few losing trades
- If you want to grow and scale your trading business, you must have systems in place (e.g. to source for new funds, research new strategies, etc.)
- The markets are always changing so be willing to adapt accordingly (or risk going out of business)
- Always be prepared for the worst scenarios (like broker going bankrupt, losing streaks, etc.) so you can make contingency plans to overcome them
Now over to you…
How else can you trade like a casino?
Leave a comment below and share your thoughts with me.
Last Updated on June 29, 2020 by Rayner