By Searching For The Way on The Capital
I recently read the book Trading in the Zone. Here I am trying to explain how winning every time trading is impossible, and how great traders never attempt to be successful 100% of the time.
Let’s take an analogy of a coin toss. An ordinary coin would have a 50% chance of getting a head (H), and 50% for tails(T) when tossed. Let’s say I have a special coin with a 60% chance of an H. I offer you to play a game with me. You can toss the coin for a fee of 10$. If it’s an H, I refund your fee and you win an extra 20$. If it’s a T, you get nothing. What would you do?
If you understand probabilities, there is absolutely no doubt about what you should do. The correct answer is, play as many games as you can. It’s free money.
Here’s an explanation: The coin gives a 60% probabilities of an H. That means, for large number of tosses, about 60% of them would be H. For 100 tosses, about 60 would be Hs and about 40 would be Ts. This means, if you play 100 games, you win 60, lose 40. That means, you pay 100 * 10$ = 1000$ to play. And you win 60 * (20 + 10)$ = 1800$. Your net profit = 800$. The more you play, the more money you earn.
That was the big picture if you played a large number of games. But what about the next game? What can we say about the next coin toss? Right, NOTHING. We don’t know if it would be an H or a T. We know it is more likely to be an H than a T. What if it’s a T. Does it mean we were wrong in betting? Does it mean that I cheated you in the game? What if you lose 3 games in a row. You lost 30$, does that mean I “wronged” you? Should you stop playing more? Is the cost of playing, 10$, not worth it anymore?
Trading is like the game of coin toss I described above. The “biased coin” is a trader’s “edge” in the market. It’s her understanding of the market, the charts, candlesticks, patterns, price actions, fundamentals, technicals, etc. which increase the chances of her winning in the next trade. It gives her coin a 60% probability of an H. A trade is a coin toss. As long as she sticks to her rules, her coin toss will give a 60% chance of wins and every trade will “cost” her no more than $10. Can she avoid losing? No way! The coin she has “prepared” with her knowledge and experience of the market, gives her about 60 wins out of 100 trades. Should she avoid losing? Not at all! One trade doesn’t make a trader a winner or a loser. As long as you win more than you lose, you are a profitable trader. Losing is the cost of trading. It’s like you paying me 10$ for a coin toss which you know is in your favor. You win more than you lose, and that’s how you recover the cost of playing. It’s just the cost of running a business.
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