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Daily Speculations The Web Site of Victor Niederhoffer & Laurel Kenner Dedicated to the scientific method, free markets, deflating ballyhoo, creating value, and laughter; a forum for us to use our meager abilities to make the world of specinvestments a better place. |
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04/30/2004
Hearts and Second-Best Systems, by Philip J. McDonnell
Hearts is a card game which I often played in college. It has certain interesting strategies applicable to the markets. Hearts is a four player game whose objective is NOT to take points. Briefly the rules are: All the cards are dealt. Play goes clockwise and the card which is lead dictates which suit must be played by subsequent players. Highest card in suit wins the trick. You are only permitted to play another card if you are void the suit which is led.
After all the cards are played each player counts the number of points he took with each heart counting as 1 point and the Queen of Spades counting as 13 points. There is one additional rule which makes the game very interesting. That rule is the Shoot the Moon rule whereby a player who is able to get all 26 points can then add the 26 points to his opponents and take none for himself.
Generally speaking the best strategy is to try to take the fewest tricks and to quickly unload your high cards. But because of the Shoot the Moon rule players are forced to play a more mixed strategy. The best players try to discard their second best card thus saving the highest card for possible use to defend against a Shoot the Moon run. Only after it is established that no one can shoot the Moon does one switch to a straight unload the highest card strategy.
The Hearts strategy of minimizing damage has a very direct and obvious analogy to stop loss and money management strategies in the market. However it strikes me that the strategy of discarding one's second best has a very appropriate parallel in market systems as well. It would be quite rational for someone who is disclosing a trading system publicly to disclose their second best thus saving their best for private use. I do not intend to imply any dishonor on anyone who shares such a system. As far as I'm concerned anyone who shares a valid system is doing me a favor and it's up to me to test the same for recent profitability.