Long & Wrong

I know that I go on a lot about probability but it keeps raising its ugly head again and again…

Out of the goodness of my heart I have been coaching  a few struggling traders.  I can’t offer any more than a moderate return after lots of hard work (because that is all that I can manage myself) but there still seems to be interest. You’d have to ask them what they have learnt from me but I do know what I have learnt from them – being comfortable with probabilistic, rather than deterministic, outcomes is key. Two basic scenarios have played out with sufficient frequency to convince me that they are important lessons in themselves.

1. After going through the basics of my approach to trading I invite them to sit on my virtual shoulder and watch me trade.  So I start another dull Monday morning and they think they are about to glimpse the Holy Grail.  My first trade loses, my second trade loses, my third trade does the same but my fourth trade, erm, also loses. It is around losing trade 3 or 4 that there is a sudden family emergency that means they have to leave their PC and I never hear from them again.  They probably consider me to be at best a fantasist and at worst a fraud.

They are not there at 16:30 on the Friday afternoon when 80 trades have returned a decent, and statistically significant, yield. Trading isn’t about Monday morning (either literally or metaphorically) it is about letting the law of large numbers play itself out in your favour.

2. My second lesson from mentoring struggling traders is that they seem to crave certainty.  What set of conditions will lead to a winning trade? The correct question of course is what set of conditions leads to a trade where the probabilities lead to a positive expectancy?  I can show you the perfect trading set-up according to my strategy and it might lose. I have  the proof though that over a sufficient number of trades it will make me good money.

We live in a world where we ‘do X to achieve Y’, well it doesn’t work here.  The best we can hope for is ‘do X to sufficiently increase the probability of Y’.  You do not nudge the win-rate ever closer to 100% by maxing the conditions ever more complex, uncertainty is part of the game, who knows when someone is about to sell a yard of USD/JPY and wipe-out your long?

This is understandably difficult to grasp (and even more difficult to apply).  The worst case of this kind of thinking is when they show me a trade that made them an absolute fortune because (their word) a certain set of conditions were fulfilled. They then go on and apply this same method  (sample size=1) again and again and again and, for those with deeper pockets, again and again and again.

The Doctrine of Chances

I don’t know how to shift people’s thinking into this ‘probability space’, perhaps if I could I would have a better success rate trying to help others.  There is plenty on the web about why we seem to struggle to think in this way, a readable starting point is here but there are no easy answers.