The art of understanding probability on investment and trading? (Weekend sharing and discussion)
This weekend, I will be sharing on my usage of applying probability. For me, for every decision that we make, whether you are confident or not, the actual chance when you make that decision to predict up or down is 50/50. It is the same logic as a coin toss/ or drawing a red or black card, the chance of being correct is at 50% chance at being right on a given toss/predicting a given card. I always use this simple ideology as simple as a coin toss/predict a red or black card and applied it to the market. For me, an analyst report or a trader's current views of probability could be completely wrong, as they can be correct most of the time based on past record but at anytime of making a decision, to me is always 50/50. Past record does not indicate future consistent performance, just that it is more likely to happen as they perform consistently. We access to information all the time, and have we ever wondered when someone is on form and accurate and you follow them, next moment the form change and you lose following their analysts or recommendation.
In the long run of average, I always believe what goes up must come down, and what goes down must come up. Hence following someone who is on form may not necessary yield good result while following someone off form may not necessary yield bad result going forward. Things may change and luck may change. I am one that believe in 风水轮流转， meaning one fortune do change. while following and they could very well be why they are not making money in the markets. Since everything in life to me is 50/50, we need to add fundamentals, insight news and info and other things to aid us to make the probability of investment or trading higher. Again, if you are on the wrong track applying the wrong things or market condition turn against you unexpectedly, no matter what you do still will result in net losses towards the end.
I would like to analyze why a lot of traders or contra players lose. Using the coin toss as an example, in the the short term, anything can happen, to me is still 50/50 regardless the shares become an uptrend stock or having good news announce. In fact the shares may sell down on news after you chase most of the time. At any point in time in the short run, the stock could move up or down hence our probability of making a profit on a position is 50% be it long or short.
I have friends who tell me hey, when I enter a contra trade, I am not doing a Tikam tikam short-term trades, they enter because of news announce, rumours or due to technical analysis. Indeed they go in with a high expectation that they will win, -: who enter a trade to lose? For the person who enter he enter a super high chance of winning but for outsiders like me I rate his chance still as 50/50. There is a saying 旁观者清当局者迷，meaning people in it will have biased view, but people like me viewing from outside will be clearer. I still believe is 50/50 chance still as in this case we still have an equal probability of making a quick profit and previous run of profits or losses does not signal what future outcomes will be. It does not happen tikam trades in the short run. Each event still only got a 50% probability, no matter what outcomes came prior, hence that is the misconception on a lot who follow those who are inform expecting I will win. I do not subscribe to this idea. The next independent trade to me is still 50/50.
Why do people make money like 9 out 10 despite chance being 50/50. Like Casino baccarat which I saw recently of a guy winning millions due to Dragon(same pattern happen for a long period), the person boom. Traders and analysts can also be on form and win many trades in a roll. In life, runs do happen even in random 50/50 events. The definition of a run refers to a number of identical outcomes that occur in a row. But the chance of that happening is low especially if the run extend on a longer stretch. Eventually by law of average, you win lots on a stretch and will lose back based on probability on a huge sample size. So when one is on a run of win, remember to keep more profit aside so that when reverse happen, you do not lose back. I have seen friends who win on a streak and quick buy properties so that they do not lose back.
Now, when is a chance of entering not 50/50. In my opinion is through the following :-
1)Knowing the insight of the company through fundamentals or knowing people working in the company who give you first hand insight. Resulting in accurate movement in the company prices long run.
2)Master technical analysis that brings consistent result that help to make you money when you apply those methods year in year out. If you apply and still lose means it is 50/50 in my opinion as those method is not working.
3)Have your own method that traditionally make money in long run consistently for years. Like understanding corporate actions, fund flow, or follow market indicators(could be certain action by key people like Yellen) that tell you to buy or sell.
Other than that to me is 50/50. Most of the time nothing is sure win so do not take risk to bet/trade all and cannot recover as lose too much. Since is 50/50, do not borrow to trade or gamble. In reality like in a casino, is worst than 50/50 as you need to factor in bid and ask plus commission as costs to entering a trade. Hence most lose in long run as assume you win half and lose half, net amount lost goes to transaction cost.
Hope for further discussion and debate. This post is not to induce buying and selling. Is more for education purposes. Please seek your financial advisors if you are unsure. Trading has risks and is never a bed of roses. Have a good weekend ahead all.