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Probabilities vs. expectations

  
  Education
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I expect to wake up tomorrow morning and not die during the night.

I expect that I will be able to get out of bed and know how to walk to the kitchen.
I expect my car will start.
I expect the other person will stop at the red light.
I expect that I won’t get hit by lightning.
 
Seeing that expectations are what normal everyday life is founded on, is it natural to think that you can expect a stock to trade in a particular direction? Only if you want to become a loser.
The markets and stocks are not everyday life. They have the ability to do anything at any time. The only thing 100% certain is that they are 100% unpredictable.
If you have expectations, it means you have an emotional attachment or interest in an event outcome. Do you expect to make money, have a winning trade, make a right decision? When they happen are you giddy with excitement, gushing to all who will listen that you are so smart. What happens when you are wrong? How about wrong ten times in a row? If you live the highs you will be living the lows. Your expectations will destroy your confidence and thus your account. Your ego will take you back to childhood where you will throw tantrums and stomp your feet looking for a sympathetic ear. “The markets aren’t fair” you say. Well the markets don’t give a shit what your want or when you want it.
Now if instead you trade the probability of a outcome to an event, you can put a wall up between yourself as a person who is on autopilot accepting everyday expectations and you as a successful trader who is ruthless in the execution of your plan. Thinking, trusting and truly believing in probabilities will save the day for you. When you think that “based on my experience, seeing a very similiar situation before, odds are that the near future direction of this stock is this way. However since this event is unrelated in every way to my past memories, I must choose the point at which my decision will be proven wrong and set a protective stop here.”
When you think this way, it doesn’t matter whether you are right or wrong. You are simply carrying out your trading plan based on your experience/edge. Playing the averages. You don’t get hurt by losing trades. You don’t get happy over winning trades. Whatever happens, happens. Being cold and calculating brings you as a trader closer to the machines that are running the show these days. (more…)

Four Keys to Understanding Uncertainty

  
  Education
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1) Uncertainty is always subjective. It is a state of mind that is derived from a mix of objective data, emotions and personal experience. To say that the market is always equally uncertain is to say that mood is always the same. It is not. It constantly changes.

If the perceived uncertainty is always the same, earnings reports would not have such huge impact on prices. We all know that this is not the case. In many cases, earnings reports provide new data that changes market expectations and therefore prices. Options premium is higher before earnings exactly because uncertainty is higher.

2) Uncertainty has become a synonym for bad mood in our everyday life.

The future is always uncertain, but our perceptions of the future vary. And perceptions define actions. Actions (supply and demand) define prices. Somehow uncertainty is used with a highly negative connotation in our everyday life. It is a game of words. Just like the weather people always say that there is a 30% chance of rain and never that there is 70% chance of sun.

3) Uncertainty is basically another word for market sentiment. High levels of perceived uncertainty (bad mood) and high levels of perceived certainty (good mood) have historically been good contrarian indicators, IF your investing horizon is long enough.

4) There are different types of uncertainty.

There is an economic uncertainty. Uncertainty leads to a decline in economic activity. Less people are hired. Old machines and software licences are used longer. Investments are cut. This is what it has been happening in Europe for 2 years.

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