Let's talk about Gambler's Fallacy …You might be asking yourself, What's that? Simply put: the gambler's fallacy is when People believe past events affect the probability of something happening in the future. Now, pattern recognition is a real thing and millions of traders depend on it which makes it a self fulfilling prophecy of sorts. With that said, for example, if a coin is tossed and heads come up 8 times in a row, they'll think that on the 9th time it is more likely to be tails. But the odds are still 50:50 for heads or tails. Winning streaks aren’t real. Neither are losing streaks…. When a trader goes on any type of streak they have simply hit favorable (or unfavorable) odds over and over again…now the caveat to that statement is that you’re trading a well tested strategy. If you’re simply guessing and throwing money at the market you’re doomed to fail. The game is all about stacking the probabilities in our favor
You might be asking yourself “how do I stack the odds in my favor?”. You would be right to ask that question!
Here are some things to ask yourself:
Do I have a Market that I am specializing in? This is a very important point. To really stack the odds in your favor. It is important to understand the in’s and outs of the markets you’re trading. If you’re an Oil Trader for example, you would want to understand not only the charts but also the news, like rig counts and inventory levels. By understanding the market you’re in you then start to build a strong foundation of what could happen. That is a form of stacking the odds in your favor. Remember, the game is ALL about probabilities.
Just for clarification the definition of “probabilities” is: the ratio of the times an event is likely to occur divided by the total possible events.
To properly understand the probabilities of the market or asset class you’re trading you’ll want to do a ton of back testing and forward testing. As a point of practice you want to see how many times something works and how well it works. Here is an example: Let's say that you’re trading a pattern, maybe its a price action pattern like a flag or a triangle or you’re trading a MA cross pattern...point is you want to monitor the pattern you’re trading and you want to document how successful it is at playing out…and to what degree.
If the pattern you’re tracking plays out 6 out of 10 times and the wins are greater than it loses, the probabilities are working in your favor. Here’s the thing though…you really need to test what you’re seeing. It is important to recognize that markets change and trading systems sometimes fall short or fail completely. Back testing and forward testing( on paper first) is very important. The data you receive will tell you whether or not you have a viable trading system, or “edge” as it is sometimes referred to. Based on you having a valid trading system (that is well tested) you then want to think about forward testing with capital. With that, you’ll want to test it with a small amount of capital!
Now that all that has been said it’s time to ask yourself some questions that will give you some direction moving forward.
What Asset Class do you want to trade?
What Markets do you intend to trade?
Are you trading equities, options or something else?
What type of trader are you?
Here is a list of the types of trading you can do once you have answered the above questions:
Day trading is perhaps the most well-known active trading style. Day trading, as its name implies, is the method of buying and selling securities within the same day. Positions are closed out within the same day they are taken, and no position is held overnight. Traditionally, day trading is done by professional traders, such as specialists or market makers. However, electronic trading has opened up this practice to novice traders. We saw this a lot with the “mem stocks” awhile back. As a point of practice I personally like to scalp the breakouts and breakdowns of key levels. Scalping is one of the quickest strategies employed by active traders. When the market changed and intraday momo plays started to fail I looked at more scalping…which has become my favorite method of trading! (for now)
Another popular form of trading is Swing Trading.
When a trend breaks, swing traders typically get in the game. At the end of a trend, there is usually some price volatility as the new trend tries to establish itself. Swing traders buy or sell as that price volatility sets in. Swing trades are usually held for more than a day but for a shorter time than trend trades. Swing traders often create a set of trading rules based on technical analysis.These trading rules are designed to identify when to buy and sell a security. A range-bound or sideways market is a risk for swing traders. Swing trading is especially popular with people that have full time jobs that can't spend a few hours in front of their screens. The potential returns on swing trading can also be huge, especially If you’re trading options or some other hyper volatile assets like crypto.
The key takeaway is no matter what you’re trading, it’s important to understand the probabilities over an extended period of time! As I mentioned before, the game is all about probabilities. One thing that I should mention is that it is of the utmost importance to compartmentalize your trades. The last trade you put on doesn't matter because it's done. Over. Finished! . Future trades are relevant as they haven’t happened yet. All that matters is the trade that you’re in. When you put a trade on and are in an active position it is important to be updating your positions probabilities. Why? Because the probabilities change with time, as does the risk factor.
The Bottom Line is this, active traders can employ one or many strategies that we talked about. However, before deciding on engaging in these strategies, the risks associated with each should be considered. It’s 100% necessary to fully understand the probabilities of the strategy as well as understanding the upside vs downside. If you have an edge that checks all of the mentioned boxes that have been working for an extended period of time over various markets you may have tapped into something powerful.