Trading Psychology Futures Stocks Options Probability Odds Mindset

Successful financial speculation is a matter of playing probabilities consistently. No trader knows what the market is going to do next. But every trader should have a good idea of what the market is likely to do next and position his or her trades based upon those perceived probabilities. The market can do anything it wants to next, but it is more likely to do some things than others. Successful traders know how to exploit these likelihoods. Unsuccessful traders are controlled by their fear and greed, not of what will likely happen, but of what might happen, and so get whipped around by the market’s dodging and feinting.

As an example, let’s say Joe starts out with $20,000 and has the opportunity each day to bet that the sun will shine or will not shine in San Diego. If Joe is right, he will double the amount he risks. If he’s wrong, he will lose it.

So the first day Joe bets $1000 that the sun will shine. But the entire day is cloudy. He loses $1000, or 5% of his stake. The next day Joe makes the same bet, but, again, not one ray of sunlight peaks through, and he is down 10%. Now Joe is a little nervous. Maybe the climate has suddenly changed in San Diego, he thinks. So the next day Joe reverses and bets that the sun won’t shine. He also doubles his bet to $2000 in order to “get back to even.” But blue skies break out, and Joe is down $4000 or 20%. Now Joe is in the grip of fear and well on the way to losing all his money.

Joe’s problem is that instead of playing the probabilities, he is trying to predict what is going to happen each day. He doesn’t seem to realize that the odds are greatly is his favor. The sun shines in San Diego about 80% of the time. That means that if he bets every single day that the sun will shine, in the long run he will win 80% of the time. These are terrific odds. But if he tries to guess which days will be sunny he will invariably do much worse that if he just placed the same bet every day.

Although the odds are in his favor in the long term, there is nothing preventing his experiencing extended losing streaks in the short term, for example five straight days with no sun. So Joe should never risk so much that a losing streak will take him out of the game. He should play conservatively until he builds up his stake enough to where he can exploit the odds without much risk.

So the key is to recognize when the odds are in your favor, and then trade without fear. It is the fear of what might happen “this time” that keeps traders from taking advantage of what is likely to happen in the long run. So, ironically, the fear of losing results in loss. It guarantees exactly what the person is desperately trying to avoid.

Successful traders learn how to think in terms of probabilities.They do not look at their current trade as a must-win scenario. They look at it much as a baseball batter looks at an at bat. Sure, he wants to get on base, but he knows in the long run what matters is his batting average, not what happens at any one at bat. Losing traders fret to no end about the current trade, and when it doesn’t work out they try to make some change in their approach to fix the problem. This would be like a batter changing his batting style every time he comes to the plate—a sure recipe for failure. This is precisely why so many traders fail.

Learning to think in terms of long term probabilies and, even more, learning to apply that mindset daily is not easy. But it is absolutely essential to trading success.