Although trading is not for everyone, I try to help those of you who have ventured into this bog with my weekly fireside chats.
Today we’re going to climb in our time machine and relive when you were a novice trader when your only concern was finding the system that would give you the keys to Fort Knox.
Do you remember the euphoria that encompassed your entire being when you finally found that strategy just for you? You remember the one that was going to turn $25,000 into $1.4 million in the 4 months?
Do you remember the feeling you had believing money would start falling from the sky?
Do you remember the excitement of a kid on Christmas morning thinking you had a magic seedling you could plant in your backyard that would grow greenbacks?
Ah, life was good back then.
Now reminisce how you felt once the hard – cold – reality of trading slapped you on the side of the head until your eyes crossed. How the sharp edges of real-world drawdowns left scars on your soul.
When the realization of what trading demands of you settles in – and it will at some point – trading can turn into one of the most discouraging and disheartening endeavors you will ever undertake.
This is the point where many would-be traders become a statistic – you know the stat that says 95% of traders lose most of their money within the first year of trading. I think it’s pretty clear why pundits always point to the fact that most equity traders fail to outperform a simple buy and hold investment scenario.
Most Fail at Trading
Why do the majority, who are otherwise extremely successful in their chosen occupations, fail so miserably at trading? Are successful traders born and not created? Is there a gene you inherit that makes you a consistently successful trader? As you are probably aware, the answer is no.
You (anyone) can be a consistently successful trader. However, you do have to make a few adjustments to your thought processes and start thinking in terms of probabilities, which is a lot easier said than done.
If you’ve been to Las Vegas, you can get a sense of what I am talking about.
Gaming corporations are just like other corporations, they have to justify how they allocate their assets to a board of directors and ultimately to their stockholders. How do you suppose they justify spending gobs of money on extravagant hotels, eye-popping casinos, or expensive headliners like Rod Stewart when their primary function is generating revenue from a transaction that has a purely random outcome?
The bottom line is casinos make obscene amounts of money consistently, day after day and year after year, facilitating an experience based purely on randomness.
Market Behavior is Random
At the same time, most traders mistakenly believe that the outcome of the market’s behavior is not random, yet they can’t seem to produce consistent profits. Shouldn’t a consistent, non-random outcome produce consistent results and a random outcome produce random, inconsistent results? What casino owners, experienced gamblers, and the best traders comprehend down to their little piggies, and the typical trader finds incomprehensible, is even random outcomes can produce consistent results. The caveat – you know there is a caveat – you have to have a quantified edge and there is a large enough sample size.
Let’s Look at the Game of Blackjack
In blackjack, the casinos have about 4.5% edge over the player, based on the rules to which players are required to adhere. This means that, over a large enough sample size (number of hands played), the casino will generate net profits of four and a half cents on every dollar wagered on the game.
Now $4.50 for every $100 doesn’t sound like much but let’s put it in perspective. Suppose a total of $100 million dollars is wagered collectively at all of a casino’s blackjack tables over the course of a year. The casino will net $4.5 million. What casino owners and professional gamblers understand about the nature of probabilities is that each individual hand played is statistically independent of every other hand.
This means that each individual hand is a unique event where the outcome is random relative to the last hand played or the next hand played. If a large enough number of hands is played, patterns will emerge that produce a consistent, predictable, and quantifiably reliable outcome. Casino operators have learned that all they have to do is keep the odds in their favor and have a large enough sample size of events. In traderspeak (I just made up that word but it works), all consistently successful traders need is an edge, follow the rules of the edge and allow enough time for the edge to work.
We’re the Plan in “Plan your Trade and Trade your Plan” – TraderJanie
“If awesome were inches, we’d be the Effiel Tower.”