Trading Lessons/Insights From Coin Flipping

tradingjournals,

The lesson of the significance of a coin flip and how it applies to trading is a pretty important point IMHO. There is a great lesson in the process of a simple coin flip and how it applies to trading and if you think about it this way, I believe it will help your trading. The lesson is that the outcome of any one flip of the coin is totally random. No matter what you do or want to happen, you only have a 50/50 chance of picking the correct outcome: heads or tails. The edge on a coin flip is obviously zero. Like in trading, a coin flip can run in multiple series of heads or tails (wins or losses) but the larger the sample size, the closer to 50/50 the outcomes will be. No kidding genius you say, so how does this apply and help my trading? Glad you asked, so think of it this way.

While a coin flip has no edge, a proper trading strategy or setup does have an edge (or you shouldn’t be trading it), however small it may be. The point being any one trade, like your coin flip, is entirely chance and you have no way to predict the outcome of the trade just as you had no way to predict the outcome of any single coin flip. You could win or lose money and you have to accept the fact you can’t know ahead of time the outcome. In other words, let go and don’t tie your worth as a trader to how any single trade works out.

But whereas on the flip of the coin, the fact you had no edge didn’t help you, oh how your edge, i.e. your positive expectancy setup, helps you in the trading world. How? The power of math and large sample sizes, i.e. number of trades. The point being that now the math works in your favor. Just as the larger the sample size, the closer you coin flips will get to 50/50, the larger the number of trades you take, the closer to certainty you will make money. The more trades, the better off you are, IF you have a good setup.

This is exactly how casinos make money, while the edge in blackjack for the casino hovers around .42% (depending on game rules), some people will make money but over the course of the year, the math of large numbers guarantees a profit for the casino.

So the power of this is that if you have a setup with an edge, it is in your best interest to follow your rules to the letter AND maximize coin flips (trades). That is a very powerful lesson and insight into something that at first glance has little value to many or to traders. So next time you struggle following your rules, think of a coin flip and how you can’t predict the outcome of any trade any better, but if you follow your rules, the power of the math will set you free. All thanks to the randomness of the coin flip.

Good trading and I hope it helps thinking in these terms.

BM
 
Quote from Big Money:

tradingjournals,

The lesson of the significance of a coin flip and how it applies to trading is a pretty important point IMHO. There is a great lesson in the process of a simple coin flip and how it applies to trading and if you think about it this way, I believe it will help your trading. The lesson is that the outcome of any one flip of the coin is totally random. No matter what you do or want to happen, you only have a 50/50 chance of picking the correct outcome: heads or tails. The edge on a coin flip is obviously zero. Like in trading, a coin flip can run in multiple series of heads or tails (wins or losses) but the larger the sample size, the closer to 50/50 the outcomes will be. No kidding genius you say, so how does this apply and help my trading? Glad you asked, so think of it this way.

While a coin flip has no edge, a proper trading strategy or setup does have an edge (or you shouldn’t be trading it), however small it may be. The point being any one trade, like your coin flip, is entirely chance and you have no way to predict the outcome of the trade just as you had no way to predict the outcome of any single coin flip. You could win or lose money and you have to accept the fact you can’t know ahead of time the outcome. In other words, let go and don’t tie your worth as a trader to how any single trade works out.

But whereas on the flip of the coin, the fact you had no edge didn’t help you, oh how your edge, i.e. your positive expectancy setup, helps you in the trading world. How? The power of math and large sample sizes, i.e. number of trades. The point being that now the math works in your favor. Just as the larger the sample size, the closer you coin flips will get to 50/50, the larger the number of trades you take, the closer to certainty you will make money. The more trades, the better off you are, IF you have a good setup.

This is exactly how casinos make money, while the edge in blackjack for the casino hovers around .42% (depending on game rules), some people will make money but over the course of the year, the math of large numbers guarantees a profit for the casino.

So the power of this is that if you have a setup with an edge, it is in your best interest to follow your rules to the letter AND maximize coin flips (trades). That is a very powerful lesson and insight into something that at first glance has little value to many or to traders. So next time you struggle following your rules, think of a coin flip and how you can’t predict the outcome of any trade any better, but if you follow your rules, the power of the math will set you free. All thanks to the randomness of the coin flip.

Good trading and I hope it helps thinking in these terms.

BM
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I agree but I wonder if the author of the thread truly understands that there are real edges in trading that you can profit on in the long run.
 
Much can be learned in the coin flipping exercise. If you have a well backtested method going back min. of ten years, you can see what the mean of losing trades in a row and what the extremes of losing trades in a row (this is not to say you will not have even larger amount of losing trades in a row in the future).
Given each flip is 50% of getting a head, probability of two heads in a row is 25%, 3 heads 12.5% and so on.

Providing the method is even if just mildly profitable, you can trade it a different way. Viewing your trading method perhaps a mean of say four trades in a row being losers, with an extreme of seven trades, you would only take trades after having four losing trades in a row, and doubling up contract size after each additional loss.

And if you have designed methods where you have low losing percentages, you can take all your regular signals and double or triple up size when you have this "mean" amount of losses in a row. I use these techniques each day when I trade.

The hardest part of the above is the emotional part of trading where over 90% of traders fail at anyway, taking trades after so many losses.
 
Quote from Handle123:

Much can be learned in the coin flipping exercise. If you have a well backtested method going back min. of ten years, you can see what the mean of losing trades in a row and what the extremes of losing trades in a row (this is not to say you will not have even larger amount of losing trades in a row in the future).
Given each flip is 50% of getting a head, probability of two heads in a row is 25%, 3 heads 12.5% and so on.

Providing the method is even if just mildly profitable, you can trade it a different way. Viewing your trading method perhaps a mean of say four trades in a row being losers, with an extreme of seven trades, you would only take trades after having four losing trades in a row, and doubling up contract size after each additional loss.

And if you have designed methods where you have low losing percentages, you can take all your regular signals and double or triple up size when you have this "mean" amount of losses in a row. I use these techniques each day when I trade.

The hardest part of the above is the emotional part of trading where over 90% of traders fail at anyway, taking trades after so many losses.
More...

What a load of crap !!! Each subsequent flip is mutually exclusive of the previous one. Its a 50% flip every time regardless of how many flips you take.

Doubling, tripling, etc is a famous method that some casino players used to "guarantee" breakeven . In practise, however, the moment you hit one very bad streak ( regardless of the low statistical odds of it happening ), you will lose a huge wad of money if your bank gets broken.
 
Quote from ksmetana:

Not sure why anyone would compare trading to coin-flipping. All you have to do is look at a chart to see that markets trend....
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What is your point?

Throw a coin and you also see trends...

Ninna
 
Quote from Nine_Ender:

What a load of crap !!! Each subsequent flip is mutually exclusive of the previous one. Its a 50% flip every time regardless of how many flips you take.

Doubling, tripling, etc is a famous method that some casino players used to "guarantee" breakeven . In practise, however, the moment you hit one very bad streak ( regardless of the low statistical odds of it happening ), you will lose a huge wad of money if your bank gets broken.
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Nevertheless, even for a coin flip RW with p=0.5 you can compute the envelope that bounds the RW. And you will see that, on average, the throws fluctuate around that envelope.

And this is where it gets interesting... (regression to the mean, anyone?) :)

Ninna
 
Quote from nLepwa:

Nevertheless, even for a coin flip RW with p=0.5 you can compute the envelope that bounds the RW. And you will see that, on average, the throws fluctuate around that envelope.

And this is where it gets interesting... (regression to the mean, anyone?) :)

Ninna
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The point is the coin knows nothing of its past; as long as its not an imperfectly designed coin, it is a 50% bet every time.

Securities are different. There are literally millions of people reviewing charts etc to predict future direction. The short term money is made understanding people are doing this. The long term money is made understanding fundamentals and/or making short term money many times over.

ps I have a Major in Mathematics.
 
Quote from nLepwa:

What is your point?

Throw a coin and you also see trends...

Ninna
More...

The trends you see with a coin are an illusion strictly due to randomness. Securities have some randomness to their short term movement but the overriding reason they trend is not random at all.
 
Quote from nLepwa:

Nevertheless, even for a coin flip RW with p=0.5 you can compute the envelope that bounds the RW.
More...

what is the definition/characterization of that envelope, and/or how to compute it?
 
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