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Three Rules for Beating the House in FX
A guy by the improbable name of Don Johnson recently took three Atlantic City casinos for more than $15 Million playing blackjack. How did he do it? By understanding the odds and not playing by the house rules. Mr. Johnson is a former casino executive who exploited the industry’s weakness for large bettors known as “whales” in the business. It turns out that if you are a large enough gambler casinos will offer you a rebate.
For example if you gamble and lose $1 Million, the house will rebate you $200,000 so your total loss is only $800,000. By negotiating these and other provisions with the casinos, Mr. Johnson was able to narrow down the house edge to nearly breakeven.
He combined his deal making skills with nearly faultless card play, making bets only when the odds were with him. Since the odds were basically 50-50 on any given hand, once Mr. Johnson got ahead he pressed his luck and was able to pyramid his winnings to a 5 million dollar pot in one 12 hour session until the Tropicana casino finally cut him off.
Don Johnson’ s amazing play was covered by many US papers, culminating in a big article in this month’s Atlantic that explains the intricacies of his game in great detail. But before you run off to Atlantic City or Las Vegas to try to replicate his run, understand that it was only possible because casinos were so desperate for business that they broke their own rules of the game.
For us traders however, there are several good lessons to learn from Mr. Johnson’s wonderful adventure. The first and foremost is that in order to succeed we need to whittle down the house edge by as much as possible. In FX that means following three very specific rules.
1. Trade on the tightest spreads possible.
At this point if you are paying more than 1.5 for euro more than 2 for yen and more than 2.5 for pound -- you are an idiot. Those are the minimum acceptable spreads and in fact you should be paying 1 to 1.5 for most of the majors. Tight spreads are useless however if your broker widens out at any sign of volatility, so a broker who may be a few pippets wider but remains very steady is generally a much better bet than the “bait and switch” ultra low spread brokers.
2. Don’t trade with very tight stops
A 10 point stop with 1 point spread means that your cost of doing a trade is 10%. If you widen your stop to 100 then the transaction cost drops to just 1%. Most novice traders miss this point entirely falsely believing that tight stops will prevent losses when in fact they will just bleed out their money through death by a thousand cuts.
3. Stand down when direction is unclear
Perhaps the single best lesson from the Don Johnson story is that he refused to play by the house rules. Instead of jumping in blindly into game (much like most traders who dive into the market without a second thought) he carefully negotiated his terms and only made large bets when the deck favored high cards. In FX, our one advantage as speculators is that we can choose to stand down when price action does not favor our odds. One of the reason why our BK Flow product is doing so well, is because I assiduously avoid any known volatility and trade only after the event has transpired, allowing the market to shake out the weak longs or shorts before assuming the true trend.
Don Johnson teaches us that you only win when you play on your own terms -- a lesson that applies as well to dealing EUR/USD as it does to flipping cards at the blackjack table.