What are the odds of winning a deal?

Run length Chance

1

50%

2

25%

3

12.5%

4

6.25%

5

3.125%

6

1.5625%

This is where we have problems. Suppose we have just made five profitable transactions in a row. According to our table, based on a 50% chance, it gives us the probability of being right (or wrong) five times in a row, and we have overcome some serious possibilities. The odds of getting the sixth profitable trade seem extremely slim, but in fact it is not. Our chance of success is still 50%.

Without realizing the randomness of probability, people lost thousands of dollars in financial markets (and casinos). The odds in our coin toss table are based on uncertain future events and their probability of occurrence. Once we have completed five successful transactions, these transactions are no longer uncertain. Our next transaction starts a new potential run. After the result of each transaction comes out, we return to the top of the table, every timeThis means that every transaction has a 50% chance of success.

The reason this is so important is that when traders enter the market, they often mistake a series of profits or losses for skills or lack of skills, which is simply not true. Whether short-term traders conduct multiple transactions or investors only conduct a few transactions per year, we need to analyze their trading results in different ways to understand whether they are just “lucky” or whether they involve practical skills. It is important to remember that statistics apply to all timelines.

Long-term results

The above example gives an example of short-term trading based on a 50% probability of right or wrong. But does this apply to the long-term? Very so. The reason is that even though traders may only hold long-term positions, their trading volume will decrease. Therefore, it will take longer to obtain data from enough transactions to determine whether luck or skill is involved. A short-term trader may make 30 trades a week and show profits every month for two years. Did this trader overcome difficulties with real skills? It seems so, because the odds of making a profit for 24 consecutive months are very rare, unless the odds are in some way beneficial to the trader.

What about a long-term investor who has made three profitable trades in the past two years? Has this trader demonstrated skill? unnecessary. At present, the trader has conducted three rounds of trading, and even from the perspective of completely random results, this is not difficult to achieve. The lesson here is that skills are not only reflected in the short-term (whether it is a day or a year, depending on the trading strategy); it will also be reflected in the long-term. We need enough transaction data to accurately determine whether the strategy is effective enough to overcome random probability. Even so, we still face another challenge: Although every transaction is an event, the month and year of the transaction is also an event.

Traders who trade 30 times a week have overcome daily and monthly odds over many periods. Ideally, demonstrating an investment strategy within a few years will eliminate all doubts about luck due to specific market conditions. For our long-term traders who have been trading for more than a year, it will take several years to prove that the strategy is profitable over a longer time frame and under all market conditions.

When we consider all timeframes and all market conditions, we begin to understand how to profit in all timeframes and how to bias the odds more towards us, so as to get a more than random 50% chance of being right. It is worth noting that if the profit is greater than the loss, the trader may be correct less than 50% of the time, but can still make a profit.

How profitable traders make money

Of course, people do make money in the market, not just because they perform well. How do we get odds in our favor? Profitable results come from two concepts. The first is based on what was discussed above-it is profitable in all time frames, or at least in some time periods you win more than you lose in other time periods.

1 point 13,983,816

The probability of matching and winning a six-digit lottery.

The second concept is the fact that there is a trend in the market, which no longer makes the market a 50/50 gamble like our coin toss example. Stock prices tend to move in a certain direction over a period of time, and they have done so repeatedly in market history. For those who know the statistics, this proves that the stock movement (trend) happened. Therefore, we end up with an abnormal probability curve (remember, your teacher always talks about a bell curve), but it is skewed and is usually called a curve with a fat tail (see figure below) . This means that if traders use trends, even in a very short time frame, they can make profits on a consistent basis.

Bottom line

Why is the 50% probability example useful? The reason is that these lessons are still valid. Traders should not increase the size of the position or take more risks (relative to the size of the position) because of a series of victories. This should not be assumed as the result of skill. This also means that traders should not reduce the size of their positions after long-term profits.

New traders can take comfort from the fact that the trading system they are studying may be error-free, but that the method is experiencing bad results from random runs (or it may still need some improvement). It should also put pressure on those who are already profitable to continuously monitor their strategies so that they remain profitable over time.

This method can also help investors analyze mutual funds or hedge funds. Trading results usually show amazing returns; knowing more statistics can help us determine whether these returns are likely to continue, or whether the returns happen to be a random event.

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