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Archives of “probability” tag
rssSurfing and Trading
– After a lull (chop, quiet market) a new set of waves (setups, breakouts) will appear. Often, the first wave is not the best wave. Don’t get too excited because you see an OK wave (false breakout) after you haven’t seen any good ones at all. Often there is a better one behind it (look for confirmation).
– If you catch a wave ride it as long as you can, until you see yourself heading into shore, rocks, or other people (end of trend).
– Get into position and be ready to go for a wave so you’re ready to take a good setup once it appears. (focus, attention)
– Once you see a wave you want, commit to it to getting on it. Paddle as fast as you can to get enough speed to go with the wave. (have a plan, preparation, confidence with entry, execute with precision)
– Don’t try to catch the wave too early, make sure it has built up enough energy to carry you along (overly eager entries, wait for confirmation)
– Don’t catch the wave too late or else you’ll catch it on the top of the wave and it will throw you down into the seabed (buying tops or selling bottoms)
– Don’t try to surf every wave (over trading), just the ones that look easy to catch and worth the energy required to catch and ride it (capital preservation, high probability trades)
Any other surfers out there have some surfing/trading parallels? – If there’s no waves (setups) be patient and enjoy the water and sun. A setup will come. If not, then it wasn’t meant to be (sit on hands day) or not a good spot (market). Come back tomorrow or find another spot. Don’t try to make something of nothing.
Risk intelligence – How to live with uncertainty -One of Best Book on Behavioural finance.
Risk Intelligence is a special kind of intelligence for dealing with risk and uncertainty. It doesn’t correlate with IQ, and most psychologists failed to spot it because it is found in such a disparate, rag-tag group of people – American weather-forecasters, professional gamblers, and hedge-fund managers, for example.
Dylan Evans PhD, and former senior lecturer in Behavioural Science in the School of Medicine at University of Cork, has written about his work in researching risk intelligence in ‘Risk Intelligence – How to Live with Uncertainty‘. Evans asserts that people in positions which require high risk intelligence – doctors, financial regulators and bankers, for instance – seem unable to navigate what Evans calls the “darkened room”, the domain of doubt and uncertainty.
Risk Intelligence is a traveller’s guide to the twilight zone of probabilities and speculation. Evans shows us how risk intelligence is vital to making good decisions, from dealing with climate change to combating terrorism. He argues that we can all learn a lot from expert gamblers, not just about money, but about how to make decisions in all aspects of our lives.
I read it once, and re-read it a second time. It is in my opinion, the best, yet least known book, on behavioural finance.
Mark Douglas’s Five Fundamental Truths
1. Anything can happen. Translated – you have no control over the market.
2. You don’t need to know what’s going to happen next in order to make money. You don’t need to be psychic, or try to predict the market. This is not to say that you cannot predict what the market will do next and be correct, only that you don’t have to, and that by trying to predict you shackle yourself to ‘the need to be right’ and the associated ball and chain.
3. Wins and losses are random – You will never know when a trade will be a winner in advance, only that the conditions that define your edge are present.
4. Your edge is nothing more than a higher probability of one thing happening over another. Your edge is no guarantee of a winning trade, just of winning over time.
5. Every moment in the market is unique. Just because a similar trade won last time does not mean it will this time, and by treating each trade as totally unique you can see the truth of the trade without relating it to ‘what happened last time’.
These beauty in these theories is that they take the emphasis off any one trade, and turn your trading into a big picture endeavour.
Cut Your Losers
A big debate among traders is whether to sell your losing stocks or hold onto them. Obviously, dependent on both the short and long-term outlook of a stock each side could have a winning argument.
Whether there is a right or wrong answer, when solely using technical analysis for your stock picking analysis, YOU MUST ALWAYS SELL YOUR LOSERS.
The great thing about technical analysis is that it takes emotion out of trading; however, emotion will always be there for other traders. That is why stocks can easily dip or jump higher in a single day – generally it is a reaction to a tangible action that just happened.
When executing trades through the signals of technical analysis, there are always stop points or places where the trade is consider a failure . For the most part, that point of interest is determined by recent price action of a stock. Learn more about the art of stops.
Technical analysis all about using the setup that gives the trader the highest probability of success. Once that setup is broken, your original probability is out the window. Get it?
Basically once your stock dips below the “failure” point the criteria that you essentially bought the stock on no longer stands. Now you are just swinging into the wind hoping for the stock to come back.
Instead I recommend you cut your losses and move on to the next trade. It’s all about keeping the odds in your favor.
Desire and Fear
Desire and fear alternate in the minds of traders as they go through the day. But let me ask you whether desire or fear dominates your thoughts and feelings as you trade?
For many traders the primary emotion is fear. They fear loss: losing profits, losing money, losing equity and even their margin. Some fear losing their touch, their feel for the market, their focus, their luck, the respect of their boss, colleagues, or mate, or worse, their own self esteem.
Other traders are flooded with the emotion of desire. They look forward to what the day will produce. They like the thrill of the chase. They have a sense of unlimited potential and abundant opportunities for profit. They anticipate improving their skills, intuition, and understanding as they go through the trading day and week.
Keep in mind that desire is not greed. Greed is an inordinate wanting. It is excessive desire and comes from a sense of scarcity, a feeling that there is not and will not be enough. Desire is healthy: greed is unhealthy.
What you feel depends upon your mental focus. Do you place your conscious and unconscious attention on the possibility of loss or the probability (hopefully) of gain? (more…)
Mathematical Expectation in Trading Systems-Must read
Here is a brief lesson in how mathematical expectation works.
On the roulette wheel there are 36 numbers, double zero, and the blank. That makes 38 spaces to bet on. Each bet costs $1 to play. The winner pays $35. To calculate the mathematical expectation of the roulette wheel you do the following:
Multiply the probability of winning by what you win when you win. And from that, you subtract the probability of losing by the cost of each bet. The difference is the mathematical expectation. If it’s positive, it’s a fair bet. If it’s negative, you don’t play.
[(1/38) x (35)] – [(37/38) x (1)] = mathematical expectation of playing roulette.
(35/38) – (37/38) = (-2/38) or (-1/19).
So in the case of the Roulette wheel, the best bet is not to play. The problem is playing Roulette is fun! Most professional money handlers don’t find losing money fun. And that’s the difference between the professional and an amateur.
Trading Wisdom – Perfectionism
Trading is not about perfection. It is about probability and progress. All charts, analyses (fundamental and technical) and trading plans are built on probabilities.
Why then, do so many traders strive for perfection? Why do so many traders miss trades, waiting for exactly the right entry and then beat up on themselves when it doesn’t come and the position runs away while they sit there scratching their heads and condemning themselves?
Why are so many traders trying to turn a game of probability into one of 100% certainty?
The answer lies in one of the cardinal sins of trading which is PERFECTIONISM.
Perfectionism can be a great help to people in many professions, but can be fatal to a trader. Perfectionists, always trying to find the Holy Grail of trading go from one service to another, from one system to another, looking for a way that they can be right all the time. YES! Now, I found it. It’s this trading room, or this service, or this indicator! Wait… something is wrong here. Not all of these trades are working and I have draw downs! How can it be that this particular method failed and I actually had to take a loss? Must be something wrong. I will try harder and look for an even better system, a more expensive service, a new and improved guru, some absolutely no-fail software so that I can have ONLY WINNING TRADES.
This is perfectionism in action. Not only does this type of irrational behavior and belief undermine and demoralize a trader, but it takes away all the enjoyment and fun of being in the markets. It leads to depression with depletion of psychic and physical energy, and leaves the perfectionist to confront his basic and overriding fear— fear of failure. In the extreme, it leads to physical and mental illness, including addiction to prescription drugs, alcohol, or illegal substances as well as other addictions. The pain of failure or the haunting fear of failure is simply overwhelming, and one turns to whatever works to medicate the pain.
“Life can be lived forwards, but can only be understood backwards” ~Soren Kierkegaard (more…)
Observation, Experience, Memory and Mathematics
“Observation, experience, memory and mathematics – these are what the successful trader must depend on. He must not only observe but remember at all times what he has observed. He cannot bet on the unreasonable or the unexpected, however strong his personal convictions may be about man’s unreasonableness or however certain he may feel that the unexpected happens very frequently. He must bet always on probabilities – that is, try to anticipate them. Years of practice at the game, of constant study, of always remembering, enable the trader to act on the instant when the unexpected happens as well as when the expected comes to pass.
“A man can have great mathematical ability and an unusual power of accurate observation and yet fail in speculation unless he also possesses the experience and the memory. And then, like the physician who keeps up with the advances of science, the wise trader never ceases to study general conditions, to keep track of developments everywhere that are likely to affect or influence the course of the various markets. After years of the game it becomes a habit to keep posted. He acts almost automatically. He acquires the invaluable professional attitude that enables him to beat the game – at times! This difference between the professional and the amateur or occasional trader cannot be overemphasized. I find, for instance, that memory and mathematics help me very much. Wall Street makes its money on a mathematical basis. I mean, it makes its money by dealing with facts and figures.” (more…)
If-Then
READ atleast twice and Read Daily :
The idea of IF-THEN scenarios in trading is often misconstrued one. I often see it being interpreted in a sense of predicting stock’s action. A trader trying to apply it in this sense tries to think in terms ‘If a stock does this, it’s going to do that“. This approach is more acceptable if a trader thinks in terms of probability instead of certainty in which case the above sentence becomes “If a stock does this, it’s likely to do that“. Nothing’s wrong with that as long as a trader realizes that probability is just that – a probability that is going to work in a statistically valid number of samples but will not predict the outcome of each given case.
I, however, apply IF-THENs in a slightly different manner. For me it’s about defining my own action in response to market fluctuations. My IF-THEN is a scenario where IF is what market does and THEN is what I do in response. My intepretation thus becomes ‘If a stock does this, I do that”.
Certainly, it’s a derivation of the version above – you can arrive to it from “if a stock does this then it’s likely to do that, so I am going to react in such and such way”. My version is just more cut and dry.
What are the advantages of this aproach and why do we need to build a set of such scenarios? (more…)