Aaron Brown: The Poker Wizard of Wall Street
Aaron Brown has been involved in finance and speculation for decades – since his college days as a trader and poker player to his current “day job” with the hedge fund AQR Capital Management. In between he was head of mortgage securities for a New York investment bank, a teacher of finance at Fordham and Yeshiva Universities, and a risk management professional at a Who’s Who of Wall Street firms including JP Morgan, Citigroup and, most recently, Morgan Stanley.
He is the author of The Poker Face of Wall Street,
a book that is part autobiography, part critique of contemporary finance, and part exploration into the world of professional poker, where many of Aaron Brown’s ideas about life, creativity, risk and ambition seem to merge. In a brief explanation of what led him to write the book, Brown reflects: “I wanted (the reader) to take my ideas as an integrated whole, not a series of contentions to be evaluated one at a time. I don’t expect anyone to accept everything in the book, but I hope everyone who reads it looks at finance, risk and poker a little differently afterwards.”
We spoke with Aaron Brown by telephone on Monday, June 9th. What follows is Part One of our conversation, which focused on his ideas about speculation and gambling – from poker to blackjack to sports wagering to, of course, trading. We also talked about some of the trading techniques he practiced as a young – or at least younger – independent trader in the years before he became a trading professional.
David Penn: I thought the subject of poker might be a good place to start, since you are just back from the World Series of Poker. For those who are a little less familiar with the poker world, is the World Series of Poker one of these tournaments that have become more and more popular over the past five or ten years?
Aaron Brown: Yes. It is the big one, and mostly because it’s the oldest. For years it was the only poker tournament. It’s now in its 39th year of running. It started as a casino publicity stunt with seven Texas players, just to bring some tourists into the casino, but for one reason or another it kind of became a gathering place for the poker community. I don’t like tournaments, myself, and I don’t like casinos, so I’ve never played in a WSOP, but I go every year in June before it gets too crazy. The tournament runs from early June to mid-July, and this year they’re actually extending it to November for the final table.
Penn: Impressive.
Brown: But in the early part, in June, the events are normal and the crowds aren’t too big. It’s sort of like an annual convention for poker players. So you can just catch up with everybody you’ve lost track of over the year.
Penn: Sure. Did you get any poker playing yourself?
Brown: Sure. I like the cash games. The World Series is a very good cash game time to play: Other people, like me, come hang out at the tournament, in addition to people who busted out of tournaments or people who are waiting for their tournament to start. So you get some very good cash game action in the early part of the tournament.
Penn: For how many years have you been going to these events?
Brown: My first one was in the late 1970s, and I would guess I’ve got 20 of them over the years. I pretty much go every year, now. Other times in my life I couldn’t get away, sometimes.
Penn: What do you think is behind this phenomenon of poker over the past years? Not just in terms of people participating, but even watching tournaments on TV. What do you think’s going on with this real interest that’s developed?
Brown: There’s no doubt about it: It’s the Internet.
Penn: Really? Online poker?
Brown: To be a serious poker player, you really have to start young. You have to take it very seriously. And unless you happen to grow up in a place where poker was taken pretty seriously, you had no real chance of becoming a serious poker player. You might learn the game later, you might enjoy it, but it was never going to be that important for you. And that basically meant the American West.
Penn: Interesting.
Brown: Maybe there were 10-20 million people who conceivably could have become poker players. Now, anywhere in the world you’ve got an internet connection, you can get online and you can play with the top players in the world. It’s just an explosion in the number of people who can play, an explosion in the quality of play as well. These kids who practice on the internet play more hands when they were 14 than traditional poker experts played their whole lives. And they’re incredibly good. Right now you’re not seeing them dominate the tournaments just because they haven’t picked up quite enough face-to-face experience, but in the next three or four years, that will happen.
And you won’t find anybody my age even in the competition any more.
Penn: I was watching an event last night. And the guy who ended up winning was a 23-year-old kid. And I’ve seen a couple of these young folks doing well. What sort of edge do these young kids have?
Brown: Well, they have tremendous experience. As I say, they’ve played a tremendous number of hands, which is very useful. Focus, energy, pliable brain, there’s a lot of stamina involved in winning a poker tournament as well. Experience helps some, but eventually talent and practice win out. Another huge advantage they have is they learned it right from the beginning. When I was growing up there were no good poker theory books. All the poker books were written by bridge players, and there was really nobody to learn from until you progressed enough in the game to meet some top players.
Penn: But now …
Brown: Now, anybody can sit down and read a book or check out some internet sites and get world-class advice. So that’s a huge leg up. You don’t have to spend years re-inventing things people already know.
Penn: There have been a lot of people who have talked about comparisons between blackjack, poker, sports wagering, trading – all these different sorts of speculative activities. And I was reading an interview where you talked about blackjack. You noted that you’re not really playing with psychology or anything like that. Instead, you’re trying to find the smallest playable edge, and then just working it over and over. In poker you have statistics involved, mathematical edges, but there’s such a huge psychological aspect to poker as you well know. How analogous is the significance of that psychological edge in poker to the sort of psychology that people deal with when they’re trading?
Brown: Yeah, it is very important. You know, all three of the games you mentioned are analogous to aspects of trading. With blackjack, once you’ve built a strategy and you’re milking it, you’ve just got to run it efficiently and be patient and make sure you plan for the downswings. Sports wagering is very much like finding a new edge in trading. For example, you’re saying, “OK, what am I going to invest in, how am I going to do it, what strategy am I going to find?” Very much like a sports wager guy who looks around and says, “What sport am I going bet on, what kind of bet in that sport, and how am I going to do better than the spread?”
Penn: Sure.
Brown: Poker is more like choosing trading as a lifestyle. That is, somebody decides, “OK, I’m going to commit a significant portion of my life and a significant portion of my financial assets to trading as an activity.” That is very much like playing poker.
If you want to make a living at blackjack, it’s kind of a nine-to-five job. There are certainly traders who do that; a lot of quant traders are like that. First, they’re going to find their edge, then they’re going to exploit it, and they’re just going to milk it and milk it until it goes away. Or maybe it never does and they just milk it. But once the system is running, it’s not very exciting. With sports betting, you have excitement every trade. However good and careful you are, you’re always looking for that extra piece of information, that extra thing to get in or out a little earlier or a little later. And poker is a very different kind of thing. Neither blackjack nor sports betting is credit-important. But poker, credit is very, very important. But poker players always lend and borrow from each other.
Penn: It’s much more social.
Brown: Poker really plugs you into a network, which is not true of anything else. Poker is kind of like saying, “I’m going to move to New York, I’m going to meet a lot of traders, and I’m going to maybe work for a hedge fund or an investment bank or maybe be on my own, but I’ll make sure I’m connected with these people so I know what’s going on.” It is much more of a social network kind of thing, a much easier way to make money. Some traders have picked trading because they like to sit alone in a room and not hang out with people very much, and just make their money on their own. They don’t even want to work for a small hedge fund. It’s a lot harder that way. You can do it, but it’s a lot more fun, a lot easier, if you’re in a network of people.
Penn: If I understand it right, you got involved in poker more heavily, more seriously, around the time you were at Harvard. Were you a natural when you started picking up poker?
Brown: To be good at poker, you need two things. To be a natural at poker, you need a certain mathematical card sense – whatever you want to call it. That is, the same thing that might make you a good bridge player, a good chess player, or something. And you also need to be very, very attuned to other people and very introspective. You have to know yourself very well, you have to read people very well. And that typically goes along with shy people. So you’re going to be a shy math nerd. And the problem is, for most of these shy math nerds, they’re not going to walk into a basement full of tough looking men and play an illegal game and expect to walk out of there with their money.
Penn: Sure.
Brown: That’s not naturally what you’re going to do. And I had to force myself to do it – it was extremely hard. I couldn’t go up to a girl and ask a girl to a dance, and I wasn’t going to go into a basement pool room where somebody told me there was a poker game going on, and do it. But I forced myself, because it did mean so much to me.
I sort of overcame that, I overcame that shyness. I overcame that risk aversion. And I believe that the things that take you far in life, are not so much your strengths, but the weaknesses that you overcome. And that was very important to me. I don’t think I ever would have had the guts to trade, I never would have had the courage to walk out on the options floor and start trading options and really bet money on things, without anyone telling me how to do it, without a big organization. If I hadn’t as a teenager, 14-15, walked into some of these basements and then, in Boston, gone to play poker games with all kinds of people all over, I wouldn’t have become the person I am now.
Penn: Would you say that the best way to start in poker is pretty much the same way you would encourage someone to start trading: you start small, with fairly uncomplicated games or strategies, and slowly work your way up as you become more successful?
Brown: I’m going to get in a lot of trouble for this. I don’t know that that’s really right.
I mean, it’s probably right in a theoretical sense, right. It would be nice if everyone were sensible and did it that way. But if you really have the poker gene or you have the trading gene, if you’re really going to be good at this, you just don’t have the patience for that. You’re going to jump in and play. And the key thing, when I interview somebody for a trading position or anything that involves a risk, I look for someone who sits around and watches people play for a bit and then wants to try it. This person knows that he’s at a disadvantage, knows that he hasn’t read any books on the thing, knows that he hasn’t studied it for years. But he looks at it, and he can kind of figure it out as he goes along.
If you don’t have that ability, if you’re really the kind of person who wants to read three books and get a degree and have somebody tell you how to do it, and practice for a long time, that’s all very sensible and it should be good to do. But if you really can do that, you’re probably not the kind of person who’s going to be good at this. I’ve got a lot of sympathy for people who get into either poker or trading and make some mistakes and go broke a few times. The most common denominator amongst really successful people is they’ve gone broke a lot of times, and they’ve failed a lot of times.
Penn: Interesting.
Brown: And there’s just a certain kind of person who is willing to do that. I explain it in option theory terms. Some people really feel like, “My life is an option and I maximize that option value by increasing its volatility. I either want to hit it big and really find something I’m good at that I love that’s a big success, or I want to go broke and then I’ll go off and try something else.” And if that’s really your attitude toward life, I think you’re set up to be successful at trading or poker. And if it’s not your attitude, then you might find the two activities very dangerous. You might learn how to do them, you might study very carefully, you might be a prudent person, but I don’t know if these trading or poker will really make you happy, even if you get good at them.
Penn: At the time when you at college, were you thinking about a Wall Street, a finance-type of career, or a trading type of career?
Brown: I’ve been trading for some time. The book that really got me into it was Ed Thorp’s Beat the Market. He was the mathematics professor who wrote, Beat the Dealer on blackjack card counting. Sheen Kassouf was the co-author on Beat the Market. In college I thought of poker, trading, and games like bridge, backgammon and gin rummy, all in the same terms, things you could do to make a living and have some fun, while you did whatever else you wanted. I never thought about getting a job.
But I think I wanted a little respectability. I was smart, it was not hard for me to get into the academic program, and it wasn’t hard to do the work. And it gave me something to do during the day, to tell people. You don’t want to say, “I sit around my room and I trade,” right. You say, “Well, I’m going for a Ph.D. in finance, which is why I’m sitting in my underwear talking to a broker.” It sounds infinitely more respectable. So I went into the University of Chicago finance PhD program.
Penn: Sure.
Brown: And then I didn’t know how it was going to work out. Would I want to teach, did I want to go to work for a big firm, did I want to trade by myself, but have the letters after my name? It wasn’t a big sacrifice. I enjoyed it, they paid my way in grad school, and they gave me a stipend. And it just seemed like a comfortable way to do what I wanted to do anyway.
Penn: Did you come from any family that was involved in finance or trading or anything like that, or were you the only one to strike out in that direction?
Brown: My dad was a Communist, although I think he’s changed his beliefs perhaps a little. Any money you didn’t work for – and he had a fairly strict definition of what “working for it” meant – was just immoral and wrong. And if you made money off of other people’s work, if you speculated or anything like that – that was wrong to him. But he was a scientist, and he really encouraged us to go where curiosity took us. Maybe that’s the real explanation for the Ph.D., that it made it okay in my dad’s eyes. You can do anything you want as long as it’s an experiment, as long as you’re advancing science.
Penn: Sure.
Brown: But the idea of just going out and trying to make money was immoral, he believed, whether that would have been poker or finance. In fact, poker was probably somewhat more respectable than doing it on Wall Street. None of my brothers had any interest. They were all engineers of one sort or another, or professors. They all took that sort of route. It just never had the slightest appeal for me, you know.
Penn: When you were trading for yourself were you very short-term oriented in terms of your trading? What kind of trading were you doing?
Brown: The thing I was best at, that was really the one thing I might have stayed trading in as a full time job, was options. And it was very short-term, very opportunistic. You’d look for mispricings. I would put out positions where I had very specific, very closely hedged positions. With very specific in-and-out points, and often these things would last less than a day. Maybe a week would be a long position for me, a long time to hold a position. But at other times I’ve traded bonds and mortgages, and I traded some stocks. Bonds was the only other area where I would say I really had worked to the point where I had a trading system that I think I could have made some money on, but it was just too boring to. The market was kind of illiquid and I was very frustrated at the inability to execute things. You see a price on a screen, and you couldn’t get it. Stuff would disappear, and you’d get one-half your trade and you couldn’t get the other. Options were great. They were so liquid and the stock market was so liquid you could do what you want.
Penn: Sure.
Brown: I never did my statistical arbitrage with stocks. I was sort of intrigued by it but never did much of that.
Penn: Could you give us an idea of the type of options trade you would have been making in those days?
Brown: Oh, sure. Now this is back in the late 70s, early 80s. And our market wasn’t quite as efficient as it was, but you still see these kinds of trades.
Penn: Sure.
Brown: Let’s say you’ve got a stock. And you’ve got two options at different strikes in the same expiry. The stock is lower than the midway point of the two exercise prices, but the difference in call prices is more than half the difference in strikes. So you’d buy the high strike call and sell the low strike call, then short a little stock for a delta hedge. Basically I would look for situations where I could put two options against each other, do a delta hedge on it with a stock, and just a fixed delta hedge. I didn’t do any daily rebalancing or anything. And I was at a profit for a wide range of stock prices. The profit range was far wider than I would expect the stock to move in a month. Any price up to $10.00 either way, I make money on this position. And there are a lot of those trades available.
I’d hold them, and if the stock started moving, say, five points, so I’m in some danger that maybe I might not make money, I’d liquidate at that point, take a small loss. And most of the time, either the proper relationships reasserted themselves and I could get out at a profit, or I just held onto it. Then you know at some point before expiry, the prices have to converge. And it was just very profitable to do that. This is before the days of computerized trading, and so just being able to calculate the stuff in your head was enough to make quite a bit of money.
Penn: Sure.
Brown: Now, of course, people have computers searching through for opportunities like that, and you’ve got to have a much better execution capability to do that sort of thing. But things haven’t changed that much. You still look for opportunities like that where you just make money. Anyway, I’ve never been a directional trader. I’ve always been a guy looking for arbitrage, looking for an edge, looking for something where I’m 90% sure this is going to make a little bit of money and I’m also 99.9% sure that I can stop it from losing a lot of money. And those are the kind of trades I lived on.
Penn: Right, right.
Brown: It’s actually quite easy to make money. People think it’s really hard. I don’t think it is. I think there are lots of great ideas out there, a lot of them are published and have worked for years and years, and show no sign of going away. And it’s easy to find your own. The problem is surviving long enough. None of these things have Sharpe ratios of 20 where you’re guaranteed to make money every year. So, you really have to be patient with them, and either have a lot of them, like we do, so you just kind of diversify, or really, really follow it very closely so you know when to get in and when to get out. The trick is to survive long enough for your edge to matter. If you’ve got a 2% edge a year, that’s great, you can get rich on that, but you’ve got to survive for 10-15 years to make that, and then the compound interest just makes you rich. But it does you no good at all if you go broke in the 12th year. You’ve wasted 12 years and you’ve got nothing to show for it.
Penn: Right.
Brown: So, you want to survive. And there is another part to that, and that’s particularly relevant now. When you want to take as much risk as possible without risking survival. That’s kind of hard for people sometimes. Especially after a loss or something, they’re too risk-averse. You do have to take risks when it’s in your favor. If you’re not willing to do that, then you’re going to either fail, or you’re going to end up taking risks at less favorable terms later on. So, I really believe that risk management, proper sizing, whatever you want to call it, making your bets the right sizes, is the fundamental key to success. Some people make better bets than others. Some people are smarter, and come up with better edges, or work more carefully, or something like that.
Penn: Right.
Brown: You’re much better off having that part figured out right, than to have a little bit extra edge on your trades.
More information about Aaron Brown and his book, The Poker Face of Wall Street, can be found on his website at www.eraider.com.