Trading – A Game Of Probability And Randomness

A big part of trading is a probability game. The market can move any directions and many times against all logic and fundamentals for a period of time.An edge in trading is the ability to have winning probabilities on your side.

Most people cannot distinguish between luck and skill when it comes to forecasting the market. At the best, I am right 50% on the timing of the trade but I am making money on >80% of the trades.

I acknowledge I do not know how to predict the market timing with certainty. The process of trading is replete with errors and thus one has to cater for it.

Apparent randomness in the market is so complex that it cannot be managed with my finite mind.

So here are some ways that help me to handle the random behavior of the market:

1. The first edge I have is  I use a Gann Method and Time Cycle to determine the short-term trend and sentiments of the market. It is a relative simple system that I had used for probably more than 10 years. Technical system does not need to be too complicated. Many technical systems will be correct >60% correct of the time if you apply it consistently. There are some subjective judgments made when comes to trend lines, support and resistance. If the system is too complicated, you will not be able to apply it consistently.

The problem is that once you have the indicators, many people tends to second guess the indicators again. Emotions of greed and fear are at play. Once you deviated, the technical system with all its winning probabilities is no longer valid.

If you have a sound system, it does not matter whether any particular trade makes a profit or a loss. What matters is that the probabilities over time are in your favor. You must remember that no system is perfect, and prepare for losses along the way. You should measure yourself on whether you followed your rules and executed your system, for both winning and losing trades.

2. Keep your position size equal in your trade. For stock with higher volatility, the position size can be adjusted lower and vice versa. Most of traders lose money when position size is not balance, a losing trade with a high position size will put a big whole in trading account.

3. Strictly apply risk control rules. It is part of the whole trading plan. In a losing trade, many traders are like a deer in a highway facing a crash. They freeze when they see the crash charging towards them. Instead of stopping loss or readjust positions according to the system, they hope that this time it will be different. Many pray to God to give them a last chance. But “HOPE” is dirty four-letter word in trading. You need to follow your rules for getting out. Even if you are wrong and got whipsawed by the market, at least you will be preserving your capital.

6. Keep a journal. It is tedious work but it will be a great help. It will help you to know whether you are following the trading plan. One day, I will write in details on how I record my trades. It is a customized system using Excel. The journal should be customized to your style of trading. Keep it simple. Allow critical information like reasons for entering the trade, profit /loss %, number of days held, reasons for adjustments and getting out.