As mentioned in earlier posts, it isn’t necessarily how much return or money you can make on something which requires you to take a risk (although almost everything requires some form of risk, it’s just not always monetary). It also depends on how much risk you are taking on. A quick measure that takes both risk and reward into account is simply dividing return by risk. And this is one way of evaluating which poker game provides you with the superior risk adjusted reward gambles. I’ve created a spreadsheet with the inputs described below, but note that the sheet isn’t limited to comparing simply online versus live play. Any two games, even different types or even different stakes can be compared. All you need is proper book keeping where you record the game played, profit and loss and the number of hours played for each of your sessions. Then, figure out both the average PnL and standard deviation of PnL for each of the game types you would like to compare. You can calculate these statistics using the “average” and “stdev” functions in excel. Note that the rake and other expenses don’t need to be taken into account here because they should already be included in your PnL numbers. Rake is much less online than in live play, but that will show up in your final PnL and be implicitly factored in.

Inputs

• Live Session Average Profit: Self explanatory. Use the “average” function provided in excel.
• Live Session Standard Deviation: Self explanatory. Use the “stdev” function provided in excel.
• Live hands seen per hour: Typically this should be around 30-50 hands per hour or a hand per minute or two
• Average hours played per live session: How long you typically play during a live session
• Online inputs: Same four set of inputs for live but for your online statistics. Note again, that this can be used to compare two different games, it doesn’t have to be used specifically for online play. All the calculations remain the same. Note that online the average number of hands per hour reaches 80-100 which is three times live play. If you play multiple tables then make sure to factor that in by multiplying 80-100 by the number of tables you play.

Calculations

• Here you will see your live and online profits and standard deviations per hand. These numbers are used for the final output below.

Output

• Two Sharpe ratio numbers will be calculated. The higher the number the better the game for you personally. On a risk adjusted basis, the game with the higher Sharpe ratio provides you with better bets in your favor.

Download the Excel Sheet
LiveVersusOnlinePlay.xls

Sample Results

In a $2-5 NLH game, let’s assume you average $500 profit with $1000 standard deviation in both live and online play. You make exactly the same amount with the same standard deviation. What are the results? Live wins with a Sharpe ratio of 0.0289 versus online with 0.0167. Why is this? It’s because you play three times as many hands online and you’re average win per hand is much lower than live.

Let’s compare a $1-2 NLH game with a $5-10 NLH game. Your average profit in $1-2 is $200 with a standard deviation of $300 while in $5-10 it is $900 average and $2500 standard deviation. Well, then the $1-2 game has the advantage with a sharpe ratio of 0.0385 versus 0.0208.  Why? This is because the swings in your profit and loss are much larger relatively speaking in the $5-10 game than in the $1-2.

Now let’s compare live versus online Omaha where you can play 6 tables at a time online.  You average $500 with a standard deviation of $1000 live and $2500 with a standard deviation of $1000 online. Then online clearly wins with a Sharpe ratio of 0.034 versus 0.0289.

Concluding Note

What this spreadsheet can help highlight is the game where you personally probabilistically can take better bets. And it calculates this at a “per hand” level. The main advantage of online play is being able to multi-table and get through hands faster than in a live game. This is a major advantage because as you play more and more hands, mathematically, your expected profit is growing linearly, while standard deviation is growing at the square root of hands played. For example, let’s say your average win per hand is $1 with a standard deviation of $5.  After 10 hands you are expected to win $10 with a standard deviation of $16.  After 20 hands you are expected to win $20 with a standard deviation of 22. See how the standard deviation is growing a lot more slowly than your expected winnings? This is where the online advantage comes into play. The higher number of hands allows you to bring down your lifetime standard deviation.

OK, even if you don’t understand the above, here is the conclusive remark, in English .  If you are able to multi-table and play a larger number of hands without letting your edge over other players drop so much to where it wipes out this advantage, then online play will be the better game for you.  But, if you can only handle one or two tables at a time online and you have a really high edge playing live because of your impressive abilities to pick up on physical tells, then live will definitely work out much better for you.

Live versus online poker [part 1]
Live versus online poker [part 2]

This is somewhat a continuation of the mad skillz post made just before this one. Poker is a great practical example of some of the ideas I touched upon there. I would definitely recommend reading the mad skillz post before this one.

In any case, a great example of people overestimating their abilities (mad skillz) can easily be seen in almost every card room. As an additional bonus, poker is a game that has numerous links back to trading and vice versa. Both require mastery of principles in logic, bankroll management, game theory, probability and statistics along with a sharp mental discipline. It is amazing to watch poor players get lucky in the most fantastic of ways and think that it’s their skills that have earned them their profits. I’ve witnessed numerous times where sub-amateur players with less than a year of experience pop off on ideas that are completely erroneous. Bad habits can be cultivated so easily because you can sometimes get rewarded for making the incorrect play, so why stop? And good habits can die because you keep getting bad beat, so why continue to do it? It’s only experience, a true understanding of odds, and a constant desire to improve one’s game that can mould one into a shark. And trust me, if you’re reading this thinking you’re some kind of pro just because you can count your outs, figure out pot odds, remain cognizant of the advantage of position, understand the concept of fold equity, and that’s basically all you really know, well, you better not quit your day job. Seriously, there is so much more to the game due to the fact that it isn’t static and it’s rather quite dynamic. In other words, if you like to start sentences with, “You should always…” or “You should never…”, then this game is not for you.

In today’s modern world, the game has evolved onto two platforms, live (like in a casino) and online. Although I hate admitting my own weakness and love only to point out the flaws in others, I’m still going to go ahead a state that I suck at the online version. I want to give excuses like, I enjoy the social aspect of the game, I’m in front of the computer for too long anyway and I don’t need another thing like poker to keep me in front of it or that I just like getting out of that house but that’s all baloney. If I could dominate the online world that would be the best and purest way to mint money. And as technologically savvy as I am, I’ve been too lazy to figure out and set-up the software programs that automatically track opponents play that give you instant stats on them. I would assume that that is pretty much a requirement for the fierce online battle, especially if you are playing multiple tables. However, I never really properly evaluated what is the better platform for a player, knowing that each platform has it’s advantages and disadvantages (minus all the weak BS arguments and only the ones that directly apply to increasing your the thickness of your wallet) which I’ve listed below.

• Reading players: Live definitely has the upper hand. Sure online you can go off of how long it takes a player to react (amongst other things) but nothing compares with being able to directly look at your opponent
• Distractions: When playing live, that’s all you do and nothing else. There is no TV/wife/mom/phone/internet/life to distract you. It’s purely about the game.
• Opponent skill level: Although this may be debatable, I’ve found that the skill level as you move up in stakes moves up much quicker online. So a 1-2 NL hold’em game online has better skilled players than a live game. This makes sense because a talented player can play more tables of a lower stakes game online, but I have no definitive proof of this.
• Number of hands: Advantage online. There are much more hands that you’ll see online especially if you multi-table.
• Number of hands: Advantage live. In direct contrast with the bullet point above; allowing an impatient opponent to play more hands only keeps his weakness (of impatience) from shining through. You don’t get to take advantage of that, especially if he is multi-tabling. In live play if an impatient player isn’t getting hands, then too bad, he’s forced to play weaker hands and make mistakes.
• Game selection: A lot more types of games and number of tables to choose from online.
• Cost: Combine the fact that the rake is less and there is no need to tip the dealer and online comes out a clear winner in this category

When it comes right down to it, these points boil down to two important quantifiable items to evaluate live versus online play and which one you should be a part of; statistical edge per hand and number of hands played per unit of time. In the next post I’ll come up with an excel sheet that any player can use to evaluate the comparison for himself. Just note that you’ll need some book keeping history of your online and live play for it to be accurate.

Live versus online poker [part 1]
Live versus online poker [part 2]

Wait, did we forget something in the last post? Ahhhh yes, just hold up a minute there bro, there is something else to consider. Variance, as always is just as, if not even more important than returns.  I’ve added two inputs into the spreadsheet, long term and short term standard deviation. This is a simple estimate of the annual standard deviation of each of the strategies’ returns for any given year. The strategies must now be compared using some kind of risk reward ratio and the measure that I’ve chosen is the Sharpe ratio which is literally the annual return divided by the annual standard deviation (risk free rate of return is supposed to be subtracted but I’ve omitted this for simplicity’s sake). The higher the Sharpe ratio the better the strategy. In the table below I’ve set the long term standard deviation to 20% which is close to what the SP500 is like, and the short term strategy to 15%. The results are astonishing, much less return is required to have a risk adjusted return equivalent to the long term strategy. Of course, reducing a portfolio’s variance isn’t an easy task but this illustrates how focusing on risk, and not just returns, can be extremely beneficial. It reminds me of the meat-heads at the gym that only work out their upper bodies and end up molding themselves completely out of proportion; chicken legs and a ridiculously huge V-shaped upper body. Legs build a strong foundation and support for your body and just building up huge biceps and a huge chest to look good ends up making you look silly. Not to mention the fact that your center of gravity ends up being so high you get knocked over easily. You see, that’s just like ignoring risk in your portfolio. If all you do is try to get some insanely high returns you’ll just end up looking like that V-shaped, twig leg mofo at the gym who keeps falling over. Stop trying to take short cuts and only workout half your body. Work out your legs dude.

# of Trades	Excess Skill
1	0.00%
2	-0.87%
3	-0.79%
4	-0.68%
5	-0.58%
10	0.00%
15	0.59%
20	1.19%
25	1.79%
50	4.78%
75	7.78%
100	10.78%
200	22.78%
300	34.78%
400	46.78%
500	58.78%
1000	118.78%
2000	238.78%
3000	358.78%
4000	478.78%
5000	598.78%



Download the spreadsheet below if you would like to play around with the assumptions I made.

EdgesBasedOnTimeHorizonWithVariance

Mad Skillz [part 1]
Mad Skillz [part 2]
Mad Skillz [part 3]

Continuing from the last post, let’s say an individual with excess cash is looking at getting into the market. He has two options, either buy and hold or actively trade and manage his portfolio.  In evaluating both ideas let’s simplify matters a bit and compare the strategies from the point of a unitized allotment of cash in each. So for example, in a diversified long term portfolio the individual will maybe have a total of 10 stocks each comprising 10% of the total investment. If he were to trade he would buy and then later sell one stock using 10% of his total capital multiple times. So, we evaluate how the one long term investment compares to a series of buys and sells of just 10% of the individual’s trading to keep the comparison equivalent. Some assumptions I made are below.

• Long Term Capital Gains Tax – The amount the investor is taxed for gains from long term investments. Set at 15%.
• Short Term Capital Gains Tax – The amount the investor is taxed for gains from short term investments. Set at 28%.
• Slippage – I assume it is 1 cent on a $25 stock which is 0.04%
• Commission – I assume it is 1 cent per share and assume we are trading a $25 stock which is 0.04%
• Average Market Annualized Return –  I assume it is 8% per year
• Average Number of Trades per Year – This is variable.

After all expenses are taken into account for both strategies, we see that the active trader is going to need an excess return to match the long term investor’s return. As the number of trades goes up, the active trader’s expense increases.  Even in the case where someone makes only 2 trades in a year versus an investor with one trade, the trader will need to make an excess return of around 1.38% or 0.69% per trade.  A naive person may not think that is much, but it is in fact quite a bit. Some of the latter numbers, (like the last one at 5000 trades a year requiring 600% in excess return) may seem astonishing, but it makes sense.  Someone who trades this much and is actually consistently profitable is typically a professional armed with knowledge, experience, custom software and often times a team. All of which of course only add to the expenses.  The final conclusion here is…if you are really looking to be an active trader then you need to know and be certain you have a quantifiable edge. And no, just because you got lucky a few times, or 10 times or even 100 times that isn’t even close to enough. Be sure you’ve got enough skill to overcome the typically insurmountable costs. It’s not an easy game. This isn’t like playing checkers against your senile grandpa, it’s chess against a grandmaster.

# of Trades	Excess Skill
1	0.00%
2	1.38%
3	1.43%
4	1.52%
5	1.62%
10	2.18%
15	2.77%
20	3.36%
25	3.95%
50	6.95%
75	9.94%
100	12.94%
200	24.94%
300	36.94%
400	48.94%
500	60.94%
1000	120.94%
2000	240.94%
3000	360.94%
4000	480.94%
5000	600.94%



Download the spreadsheet below if you would like to play around with the assumptions I made.

EdgesBasedOnTimeHorizon

Mad Skillz [part 1]
Mad Skillz [part 2]
Mad Skillz [part 3]

When it comes to the markets in terms of main street investors, they usually fall into one of three categories.  Long term investors, who believe in buy-and-hold and who focus on keeping their costs, like slippage and taxes, as low as possible constitute category one.  Next come the ones that for some odd reason believe that they have skills in selecting stocks and so they actively manage their portfolio.  And lastly, you have the swing and day traders that get in and out of stocks as fast as they can.  Each strategy has its merits and downfalls, but in essence the more you trade the greater your edge, or in other words skill, needs to be to make up for the costs (which can be significant) of doing so. The cost of placing a trade includes the following, in a rough descending order of impact:

• Taxes
• Slippage
• Time and effort
• Commissions

Out of these items, long term investors have the upper hand.  They save on taxes (through long term capital gains tax breaks) and pay less in slippage and commissions due to the very fact that fewer trades are placed.  So this begs the question, how much skill/edge does a shorter term investor need to overcome these costs?  It’s pretty easy to come up with an elementary formula to figure this out.  But, it’s a pretty difficult question to answer because to figure it out, you need to be truthful with yourself. Actually, being truthful isn’t even enough.  I’m not sure what it is, but almost everyone has this flaw of overestimating their abilities in games of chance.  And let me tell you, investing or trading is most definitely without a doubt a game of chance.  People seem to think that because it’s so easy to log on and buy and sell things here and there that somehow they can be instant pros, or at least competent amateurs.  If they’ve read a book, forget about it, in their minds they are destined to become the next Warren Buffet.  Even if you don’t think like that, trust me, you’re still overestimating your abilities.  It’s easy to think that the market is an easy place to wander around in because you see the idiot next door making a killing and think to yourself, if he can do it, it must be simple.  Or after doing countless hours of research and studying you think you know all there could possibly be to know.  Or maybe, you’ve had a few winners and your confidence has been snowballing with each success.  Well, let me tell you, what you didn’t see was the amount of risk your neighbor was taking to make those gains. There is a ton left for you to learn, you just can’t see what you don’t know yet, and the one trade that will wipe out your gains is ahead of you.  The problem is, this isn’t a sport like basketball or a profession like medicine.  In any sport, if you think you’ve got mad skillz you can easily find out that that is not the case by going up against a pro.  To become a doctor you need almost a decade of training. But to invest all you need is a few hundred bucks.  There is no Michael Jordan for you to go up against and show you, that yeah, you actually suck at this game nor do you need a degree to hang on your wall as proof of your  knowledge.   The recipe for disaster is the intelligent guy that reads a few books, opens an account and starts getting lucky.  As confidence grows, so does the amount he’s willing to risk until one day things turn on him…

There are countless institutions out there that have teams of smart people to analyze financial statements, do thorough market research, and investigate and scout out the competition; they consult economists who can offer advice on the bigger picture; the have dinosaurs with decades of experiences with the market, relationships with exchanges and brokers, computer algorithms to buy and sell securities with minimal impact, etc. Do you think you can go up against these institutions that have every advantage against you? Do you really think that you’ve spotted an opportunity that one of the numerous analysts or the constantly scanning proprietary software programs hasn’t picked up on?…Really? No offense, but who the F are you? You’re a nobody, stop lying to yourself, you just can’t compete. Sure, you can get lucky, but don’t tell me you’ve actually got any kind of talent for selecting stocks. And the silly thing is, the game isn’t even about “selecting” stocks, it’s so much more esoteric than that, but for argument’s sake let’s keep it simple here.

This game of chance is analogous to hunting. In this example, think of deer as opportunities that show up in market. You are out there with your rifle trying to take down a deer or two to feed your starving family. The only problem is there are many other people out there trying to do the exact same thing. On top of that you’ve got institutions that have hired people to do this all day every day. And to make matters worse, robots and satellites have been developed to quickly scan the area for deer in a matter of seconds. All you’ve got is a few rounds of ammunition and a few hours on the weekend to get out there and find something. Face the facts, you just can’t compete.

In part two, we’ll figure out how much skill you’ll actually need if you are still looking to enter the game and compete.

Mad Skillz [part 1]
Mad Skillz [part 2]
Mad Skillz [part 3]