How Professional Gamblers Manage Risk

Playing The Game Like A Pro

So you’ve decided what kind of trader or investor you are, and you’ve experienced successes and failures, but somehow the numbers aren’t adding up.

This is where risk management or money management comes in.

This is not the first time people have heard of the term risk management, and there are many ways to manage risk ranging from simple bet-sizing to rocket science. In reality risk management boils down to two things:

• Staying in the game long enough by minimizing the adverse impact of losses to your portfolio.
• Leveraging the profits from you winners to contribute to the growth of your portfolio.

The classic adage “cut your losses, let your profits run” is a simple way of describing it. But for most people it just means using stops and managing profit targets. I won’t go into the complex engineering degree kind of money management, but introduce some ideas I encountered from, interestingly enough, professional gamblers.

The Sports Betting Underdog says it succinctly:

Based on my nearly two decades of sports betting experience, I view this as the most valuable “secret” there is: THE HOUSE WINS BECAUSE YOU BET TOO MUCH PER GAME. You run out of money before you have a chance to let the laws of large numbers work for you. They are banking on your lack of discipline. That’s the main reason (not bad picking) that most sports bettors lose and why The House laughs to the bank.

How Much Is Right?

Those who have read literature on games of chance have heard of the term martingale or progressive system. This concept is where you increase your bets everytime you made a bad bet, with the idea that in a chance setting, good bets will eventually follow bad bets. By increasing bet size on losses, you are able to recoup former losses once you win. The opposite idea is anti-martingale or forward progressive where you scale up bet sizing when you are winning. The idea here is to capitalize on streaks, which occur quite regularly even in chance games.

But ask the pro gamblers about this and you learn something startling: pro gamblers don’t believe in progression betting. They keep their bets flat every time.

Why is this so? R. J. Miller who is a professional sports bettor argues:

The problem with bet size is not the streaks, but the breakeven. If you have a 56% advantage on each bet, over 200 games you will win less than 50% about 17% of the time.You will win more than 60% about 17% of the time. Winning 100 and losing 100 with a 5% unit, you will lose 50% of your bankroll to the vigorish. (100 wins times $50 less 100 losses times $55 equals minus $500 on a $1,000 bankroll). You will lower your bet and never get even.

One flaw with stepping up bet-size is that you base the decision on your past performance, which as we all know by now, is not a guarantee of future performance. Instead, Miller recommends keeping your bets small, risking 1%-2% of your portfolio at a time.

For a trader, this doesn’t mean just using the equivalent of 1%-2% of your portfolio, but sizing your position such that the amount you are risking (from entry point to cut loss point) is 1%-2% of your portfolio.

Why bother with small size? From Miller, we get two advantages to this. The first is that risking a small amount not only ensures that you stay in the game even with a bad string of losses, but also makes your position psychologically easy to handle, especially also during bad times.

Makes sense? But we’ve heard that before. What I found interesting is the second benefit of such a method cited by Miller, which I paraphrase in the context of trading:

Let’s say you have a method that has an edge a little over breakeven: say 56%. If you risk 1% of your portfolio, and you do 1,000 trades, you have effectively risked 1,000% of your portfolio–or 10 times your size! If your profits are roughly equivalent to your risk, that means that over 1,000 trades, you’ve won 560 of them and lost 440. This means a net of (560 – 440) 120 winners over losers, or a return of 120% of your capital (assuming each win is 1% of your portfolio).

Isn’t it weird that a small bet risk on just a small statistical edge can do the equivalent of doubling your capital over time?

Starting Out VS. Staying In The Game

Ted Severansky, another pro gambler, makes a further interesting point about the differences between people starting out vs. those already long in the game:

Bettors with larger bankrolls must bet a lower percentage on each wager. Firstly, you have more to lose, so protecting your investment becomes crucial. It’s one thing to lose a couple hundred dollars sportsbetting; it’s quite another to lose a five figure bankroll. And you must think about what will happen if you do lose, because losing, while extremely undesirable, is a possible outcome. A rational bettor accepts this risk, understands it and makes his or her decisions accordingly.

When you are starting out, you can risk large amounts, because the loss of your stake can be easily replaced by other income sources, but as you get bigger, you actually risk less and less of your stake. This increases the chances of you surviving the game as time passes. This is totally the intuitive opposite of getting and betting larger amounts as your portfolio increases.

Personally I can count many occasions where that kind of practical thinking might have rescued me from anguish over the years.

Translating the mental mindset of Miller and Severansky to trading is a different way of looking at investments compared to the traditional “home-run” mentality. But this isn’t suggesting that the rest of professional gamblers have the holy grail. This just illustrates that just like there are many trading styles, there are also many ways to manage risk.