Think in Odds

D

Demarco8

Money Management by Mark Forrester

Think in Odds
Most traders have a serious problems thinking in odds because it is against our nature to take on a position without being 100% sure that it will be a success. Losing hurts, it is painful; taking a position knowing that there is a chance of loss is usually avoided. Traders want to "know" what is going to happen and therefore look for the black and white in trading. Black and white thinking does not exist in trading.

A trade can be right and still lose. All indicators can be aligned and the trade can still lose. Even if the system is 99% accurate, there is still a chance that the trade will be a loss. Most traders are unable to accept this and it causes frustration. By learning to think in odds, a trader can both vary their trading according to odds of success and accept losing trades a lot easier.

The whole concept of odds and probabilities is a subject that most novice traders avoid, but is absolutely one of every professional trader's secrets for success. Trading the financial markets is all about managing risk; nothing is 100% accurate or works 100% of the time. There is always a certain chance, certain odds, and certain probability that a trade will work or won’t work. Even if a trading system generates 99% chance of success, there is still that 1% chance of failure. Nothing in trading is black or white, everything is somewhere in the gray. It is the job of the trader to determine how gray the trade is, what are odds of success. The trader can then adjust their trading based on the probability of the specific trade and the probability of the trading system that he uses. By figuring out exact odds of success, the trader can figure out his edge and maintain it
There is an old investing saying about cutting ones losses and letting profits run. What this means is that you should strive to keep your losses manageable, and ensure that no single trade does too much damage. The thinking here is that if you keep the losses small, the profits will take care of themselves. In the case of profits, you can exit the position once you have determined that the price has come very close to your objective area meeting your profit target.
But, what exactly is a small loss? What's a large enough profit? There is no one answer, and what is right for one trader will not necessarily be right for another. It all depends on the volatility of the market. When there is a fast market you must adjust your risk in accordance to your entry and exit points.
High volatile markets give you the opportunities to make huge profits because when you are correct in a trading decision, the market will move quickly away from you entry point. This will help in staying confident that you will profit from that trade. Inversely, if the trade moves against you, it will take discipline and a quick decision to limit the loss. Also during times of high volatility a trader will get more bang for his buck. Meaning the profitable trades will outweigh any commission costs that a trader would have to consider during times of low volatility. The market will also tell you if your are right or wrong in a very short time, making it easier to just react to the market instead of over analyzing it.

In moments of high volatile markets and favorable trading, it is important to push your profits as far as the market takes them. Once you build up a solid lead, a trick is to hide the profit/loss running total at the bottom of your screen. You must understand the nature of the market to make large profits. During the day you must realize that at a point where you are up $5,000 on the day your account may go to $8,000, back to $5,500, back up to $9,000, and from there, perhaps, all the way up to $20,000. See the mistake of quickly taking a profit just because you might not like volatility? Those people who took profits at $8,000 were not around to take the ride up to a $20,000 account. Pretend you are one of those people with the $3,000 gain in your account. Instead of simply protecting your entire $3,000 profit, why not be more aggressive with it?
 
Some good points above indeed. To those I'd like to add a comment that I've rarely seen addressed in the popular psychology books by Douglas et al; namely that a trader's ability to think in probabilities assumes that the trader has an edge which can be played out over the course of his sample.

I have no data for this, but would be willing to bet that the majority of traders fail because they have no edge. Hence, they turn to psychology to remedy the situation, but that does not change the underlying problem, which is a lack of edge.

When you have no edge, your fear is justified because it is a direct result of your subconscious deep belief that you are uncertain about your trading method. The fear acts as a warning to prevent you from blowing up.

Now of course, when one finally acquires an edge, to undo all the damage done by prior trading, one needs to learn to think in odds all over, but this time backed by a ton of data and records and experience/screen time which aligns the deep belief in one's edge with the conscious goal of not letting losses get in the way of the result that lies at the end of the trade sample.

Mark, in your experience at the Merc, have you seen people fail mostly because they didn't have an edge to start with or mostly because they did not/could not learn how to think in odds?
 
profits dont take care of 'emselves; u gotta work hard to build up your stake over different levels and consolidate at tgt areas; this is a neverendin' process that takes a lot of care and attention. all the old sayin' found on tradin' websites are mostly crap and designed to give some simple rule not to blow your acct. none of the shit i read from the so called self proclamed gurus helped me see the complexity of managin' positions and risk... and above all make good money.
 
Quote from Demarco8:

Money Management by Mark Forrester

During the day you must realize that at a point where you are up $5,000 on the day your account may go to $8,000, back to $5,500, back up to $9,000, and from there, perhaps, all the way up to $20,000. See the mistake of quickly taking a profit just because you might not like volatility? Those people who took profits at $8,000 were not around to take the ride up to a $20,000 account.
More...

It may go to $20,000 and it may not. Just as your logic dictates, you have no way of knowing. Always sell too soon! If you have a profit, take it. No one knows what the future will bring. And yes, many times the market will go on without you, and you will want to cry. Part of the psychology of trading.
 
"If you have a profit take it" Not to be disrepectful, but that not the greatest idea.

Ever trade, you should predefine a target, because you always must base every trade decision on a risk/reward basis. Why would a trader risk a point, if he was only seeking to profit on one point. Always look at a best case scenario, where your pr ofit should have at least a 1 to 3 ratio. Otherwise your commission bill will kill you in the end. At the Merc, I was the top trader for my company, I must have seen 300 traders blowout during my stay at my firm. They always were taking profits to quickly.

But obviously if you have signs that the market is going to turn against you, get out immediately. But never just get out a winning position just because "hey I made a profit" doom scenario
 
Here's a fun one.

The hot list you prepare in the evening after hours has daily profit ranks that show in the 4 to 7% range.

In the AM one of your holds (a stock you own) begins to drop in its prior few days %/day that was running better than the prior hot list %'s/day.

How do you do the cross over?
 
Quote from Demarco8:

"If you have a profit take it" Not to be disrepectful, but that not the greatest idea.

Ever trade, you should predefine a target, because you always must base every trade decision on a risk/reward basis. Why would a trader risk a point, if he was only seeking to profit on one point. Always look at a best case scenario, where your pr ofit should have at least a 1 to 3 ratio. Otherwise your commission bill will kill you in the end. At the Merc, I was the top trader for my company, I must have seen 300 traders blowout during my stay at my firm. They always were taking profits to quickly.

But obviously if you have signs that the market is going to turn against you, get out immediately. But never just get out a winning position just because "hey I made a profit" doom scenario
More...

Mark,

Those 300 traders, would you say that they were taking profits too quickly because they just couldn't wait long enough due to mental weakness, or was it because their method did not have the edge to provide the 3R winners that you refer to above?

My bet is that the vast majority of these traders simply did not have a way to get 3R for ever 1R risked. In my experience, it is VERY difficult to do that consistently on an intraday basis, on every trade, without getting into win ratios below 30-40%. That means taking 7 1R losses in any 10 trade sample, which most simply do not have the stomach for... not to mention that your expectancy under such a system is tiny enough to be wiped out by commissions/slippage if you're not a member of the exchange.

I think your first post is right on though, not to detract from that at all. Because when you finally have a method with positive expectancy, if you can't execute by thinking in probs you're just as dead in the water...
 
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