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# Probabilities

A comment that I just made in this topic Markets in Profile got me thinking about probabilities and I thought that it deserved its own thread.

Success at trading is all about have the probability of winning in your favor. That's a simple statement and it's how the casinos make money day in and day out.

One of the problems we face as traders is the calculation of the probability. How do we know if the series of trades that we are taking really does have a higher probability of success or not?

Well, for one thing we can back test our strategies. But that doesn't always give us the probability factor because of the many complexities of back testing.

Another is to do pure statistical testing of price movement after a signal. This is a type of back testing but without using money management.

In many ways I think that there is a lot of merit in having a very simple money management strategy of all-in and all-out and use probability of movement rather than trying to fool around getting the nuances of scaling in and scaling out down to a fine art.

There are two approaches to this all-in all-out strategy. You can find a signal that will "move" the market (1) more in one direction than the other 50% of the time or (2) the same amount in one direction a higher percentage of the time. You then go all in at entry and all out at target or stop. So long as the probabilities remain in your favor it is then a matter of repeating this as often as possible.

Examples in the E-mini S&P500:

(1) Your signal shows that the market will move at least 3 points in one direction without first moving 2 points in the other direction at least 50% of the time. Your win/loss ratio is 50% but you make on average 0.5 points for every trade you take.

(2) Your signal shows that the market will move 2 points in one direction 60% of the time and 2 points in the other direction 40% of the time. Your win/loss ratio is 60%. For every 10 trades you make 12 points and lose 8 points which is an average of 0.4 points for every trade that you take.

Success at trading is all about have the probability of winning in your favor. That's a simple statement and it's how the casinos make money day in and day out.

One of the problems we face as traders is the calculation of the probability. How do we know if the series of trades that we are taking really does have a higher probability of success or not?

Well, for one thing we can back test our strategies. But that doesn't always give us the probability factor because of the many complexities of back testing.

Another is to do pure statistical testing of price movement after a signal. This is a type of back testing but without using money management.

In many ways I think that there is a lot of merit in having a very simple money management strategy of all-in and all-out and use probability of movement rather than trying to fool around getting the nuances of scaling in and scaling out down to a fine art.

There are two approaches to this all-in all-out strategy. You can find a signal that will "move" the market (1) more in one direction than the other 50% of the time or (2) the same amount in one direction a higher percentage of the time. You then go all in at entry and all out at target or stop. So long as the probabilities remain in your favor it is then a matter of repeating this as often as possible.

Examples in the E-mini S&P500:

(1) Your signal shows that the market will move at least 3 points in one direction without first moving 2 points in the other direction at least 50% of the time. Your win/loss ratio is 50% but you make on average 0.5 points for every trade you take.

(2) Your signal shows that the market will move 2 points in one direction 60% of the time and 2 points in the other direction 40% of the time. Your win/loss ratio is 60%. For every 10 trades you make 12 points and lose 8 points which is an average of 0.4 points for every trade that you take.

My mistake, 35 to 1 and not 36 to 1. I just took a guess because it's been a long time since I played single numbers on a roulette wheel.

Yes I agree the odds are huge. Interestingly, if you read Fooled by Randomness, he explains that if you are playing those types of odds that you are much better off (i.e. you have the highest probability of winning) if you place all of your money on a single number once and lose it all or win big on a single spin and then leave.

Yes I agree the odds are huge. Interestingly, if you read Fooled by Randomness, he explains that if you are playing those types of odds that you are much better off (i.e. you have the highest probability of winning) if you place all of your money on a single number once and lose it all or win big on a single spin and then leave.

One would be better off taking that all or none shot with the don't pass line in craps or banker in baccarat where the house is not as strong.

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