Tag: probability

The skeptic bull mindset … or how to look at stock tips

I will attempt in this post to make the bridge between statistics and probabilities in the lightest possible way! This will position us with the right mindset when trading!

All what I have written so seems to be fine with you, and therefore if you want to convince me to follow you on a trade idea on ‘Thin Air Company’ (TAC), you need to give me the following information:

  • When to enter? At which price?
  • What is price objective?
  • What is the exit strategy?
  • What is the probability of success?

Last question might seem very puzzling to you because of one of the following reasons:

  • you don’t have statistics about your trading methodology because you can not program back testing, and no clue how to derive probabilities from statistics on past data (very good point, it is indeed too complicated to explain in a blog post!)
  • You are very bullish on TAC because you got advice from Sure Winner Top Notch Wall Street Analyst (SWTNWSA)
  • You got a tip from that Famous Marabout Who Can Also Repair PC Hardware Failures Remotely (FMWCAPHFR)
  • You are using Extra Sensory Perception To Forecast Market Movements (ESPTFMM), it usually fails miserably but this time it looks like perfect setup
  • You Won’t Tell Me!

Do not worry, we are going to play a little game with little bit of money to spice it up. The rules are pretty simple:

  1. If your trade idea is profitable, I give you 10$
  1. If your trade idea is a looser, you give me any amount. Let your brain decide the amount! Since you are so bullish, and for this example, I assume you will play 500$

If you think I am too impressive to play against, imagine you are playing with Warren Buffet!

Now we are all set up for a probability calculation from your perspective! You need to solve the little equation system below:

Probability(Winning)/Probability(Loosing) = 500 / 10 = 50

Probability(Winning) + Probability(Loosing) = 1

Easy? So you (your brain) estimate the probability to win to be about 98%!

Let me be honest! Even with this huge asymmetrical setup, I will take the bet!

Why?

Let’s look at the expected value from my perspective, which takes into account what I know!

Best stock pickers score 85% winning trades and even with this value and this particular set up (500$ vs 10$), I have a positive expected value! I might not win this time, but if we play together a few times, I am almost sure to get those 500$ notes fly into my pocket!

Now think about it the other way around: if I have positive expected value, you have not! One way to overcome that is to significantly reduce the bet size, which in turn will also give you a better idea of the probability of success!

In summary, it is perfectly right to be bullish (in the sense of opinionated whatever market direction) and we need the bull force to enter trades. At the same time, you need to be skeptical about what your are being told and evaluate correctly the probabilities of winning, even with simple methodology as above!

And remember the following conclusions:

Sure winners ideas are sure to make you a looser over time!

Loosing risk consciousness makes you a sure winner over time!

That’s it! Until next time, trade safely!

Random comments, some answers, and other random thoughts…

Thank you all of you for writing supportive comments. This blog is, as far I know, absolutely unique, I have no competition! Maybe I should charge a few hundred bucks just for viewing,… just kidding!

I am going to answer here in bulk manner to the comments.

The blog platform

The blog is powered by WordPress but is an offshoot provided by https://vivaldi.net/ Vivaldi is an awesome browser, but they also offer a free web-mail, a very good alternative more privacy focused that Gmail and similar, plus a free blog. You can have your blog up and running in less than 10 minutes. Should you start your own blog on a related subject, let me know and I will reference here. You are also welcome as guest writer on this blog.

The blog is surely working with latest navigators such as Firefox or Vivaldi, but you may experience problems with old Internet Explorer.

Starting a new blog

I am no guru about blogging, I am sure you can find good material on the web. I started out with same idea as the posts I write: Keep It Simple Stupid (KISS). After a few months of writing, I see audience is increasing through number of real comments (not spam), so great!

Pretty much you can revive your old desktop with a new wallpaper, you need a good picture so that your blog looks good. I recommend your browsing Deviant Art, they have plenty of original pictures and web art.

About comments

I don’t know how WordPress behaves when you leave a comment and if you get many annoying emails. If you come back often here, use a disposable email for entering public comments, e.g. this service or that one

Captcha for plug-ins: I do not know.

If you want more in-depth exchange, you are welcome to email me: dragon trader at vivaldi.net. Or @ randomerrance on Twitter.

RSS

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About statistics and probability

There is a big difference between these two notions and you must understand it. As finance often says “past performance is not indicative of future performance”. We may hate to say it, but they are right. You can calculate statistics of past performance, e.g the number of winning trades over last 10 years, the average performance, … and thus the overall expectation of the strategy. If the expectation was negative over the last 10 years, why do you believe it will work in the future?

Also as discussed in some posts, the probability of winning does not tell you anything else than, on average, you should win x% of the time and so you can experience long loosing streaks based on that probability. Also having a good probability of winning (say 51%) does not mean a positive expectation, you need to control the losses and make sure the gains fare much better than losses, at least 2x. Stock picking comes into play here: small volatility also means low risk of course but low gains, most often not good enough to have positive expectation. Trading is playing with stocks or securities that have the capability to land you big gains! Do not look too far: Apple is such one, as well as Microsoft or even Visa. Of course, many Nasdaq stocks such as Tesla are far better choices to push your expectations skywards!

Investment publications often boast about their past wonderful performances, they even sometime annualize the figures (e.g 1400% based on 1 trade that made 20% in 10 days!) but they never report publicly about their failed trades, their overall performance and expectation. Some may be quite good a stock picking, but you should always wonder whether the writer is not somehow the market maker, especially with small caps, so he needs many subscribers not only to have a very profitable newsletter but also moving the market in author’s intended direction! The folks are Sock Gumshoe do a wonderful work deciphering the teasing of such newsletters, so a good source to find trade-able stocks!

That’s it! until next time, trade safely!