I often hear game theory talked about in a trading context, but I never quite see how can it be applied.
Game Theory is really a negotiation tactic to get to the equilibrium solution. I don't see how that would work in trading. If you were trying to buy a company you could use it to get to the right price. Bluffing in Poker is game theory applied. I like the example in A Beautiful Mind where Nash & his friends try to work out which girls they should try and pick up at the bar.
it can be used in processing how other people will behave - people that you are betting on or against.
Book to read, The man from the future. Von Neumann and game theory. It can be applied to negotiation tactics, specially during the cold war. "The smartphones in our pockets and computers like brains. The vagaries of game theory and evolutionary biology. Nuclear weapons and self-replicating spacecrafts. All bear the fingerprints of one remarkable, yet largely overlooked, man: John von Neumann." In trading a head fake (breakout and return) can be looked at as the market was bluffing and trying to make you go long. Also stocks are the bigger idiot's game, you are passing on value to others, although you may think the value is going to drop. A pump and dump system also could be looked at through game theory's eyes. ------------------------------------- Another answer: https://paradigmlife.net/eye-opening-look-using-game-theory-markets/
You can use it to think about how a market participant will take risk/avoid risks. The "rules" of the game are margin, access, and tax treatment. Some traders can spread vols, rates, and indexes, and have full access to the OTC market and real-time news flows (BBG). Then there is the tier below, with retail trading solutions and portfolio margin. Below that, traders who can't qualify for portfolio margin, but can still spread rates and indexes or FX and commodities. Then below that is cash accounts in US listed markets. That's an overview of 'ability' of participants. Then there is 'investment horizon', domestic and foreign investors, and active/passive PMs. There's a lot to think about in terms of incentives and motivations.
I think if you understand what separates pro long term winning gamblers from the losers there is a lot traders can learn from them. This info below was from a study done for casinos on pro winning gamblers - what seperates them from the losers or is it all luck? Bankroll: misunderstood by novices, you need a bankroll of 100 times your max bet. Recommended to have at least $75,000 to have a chance to make a living. Only 1 in 500 card counters are profitable over the long run. Winning pro gambler expect to have winning & losing swings - even the best of the best has losing streaks lasting months. Their bet size expands & contracts with their bankroll. They bet small when they don’t have an edge & larger when the count is favorable (true 1), this is bet spread - they use it aggressively. 6, 8, 12, up to 20 is typical. Blackjack card counters often target betting of one-half the Kelly optimum bet size because it results in one-half the bankroll volatility while providing three-fourths of the maximum possible bankroll growth rate. They win over the long run - they expect variance; losing days, weeks, and months. Professional gamblers rarely sustain a long term winning percentage higher than 55 percent, and it's often as low as 53 or 54 percent. The measure of success is not his percentage of winning bets, but the relative amount of profit they make in relation to risk over any given period of time. Why gamblers lose: Bankroll to small - takes $10k to avg $10 per hour over the long run. They fail to realize how bad the losing streaks will be. Too timid to vary bet sizes enough to make any substantial gains. They brag to their friends about their winning days while hiding their losing days - self deceit. Generally speaking, non-professional gamblers go wrong by risking too much of their bankroll on individual bets. They don't spread their risk thin enough over a big enough number of bets. Professionals use smaller bet sizes in proportion to their bankroll over larger numbers of bets. As a matter of fact, one good way to spot a non-pro is they risk more than 1-2% of his bankroll on each bet.
When you are desperate for money you play russian roulette for money. Check out the movie 13 Tzameti click above to watch.
One of the faults of Game Theory as applied to Finance is operating under the premise that all players are rational decision-makers. More insights would be had by using L. Harris's 'Taxonomy of Trader Types' intersecting with Behavioral Finance and emotional decision-making when viewing Game Theory. Ed Seykota of 'Trading Tribe' fame said: https://www.elitetrader.com/et/thre...ryone-gets-what-they-want-from-market.317295/ --- Being profit-driven, counter-intuitively, is not the primary motivator of all the players in financial markets. References: https://www.perplexity.ai/search/how-is-game-theory-applied-to-LhkOzB39SICSe66YMJF6hQ