The Myth of 'Right' or
'Wrong' on a Trade
This article will address one of my
greatest pet peeves in the area of market education, the concept of being
'right' or 'wrong' on a trade. It's such a pet peeve to me because I think that
it is not only destructive to traders, but fosters thinking that I feel is
simply inconsistent with a proper viewpoint on probability in trading. I have
never seen the following concept presented anywhere before, although I can't
say that it has never been written about. If it has I haven't read it, and I
came to the following conclusions completely independently.
There are a lot of
great books out there now that explain trading in probability terms. We have
finally reached the point where many trading educators are explaining trading
in terms of probability, and working probability aspects into their material. I
am a big fan of using probability in my own trading. Way back in college one of
the best and most enjoyable courses I took was 'Probability Theory and Its
Applications'. The application part was almost entirely game theory.
This was quite a
bit before I became involved in the market, but I had a huge curiosity about
games and how probability affected them. I was forever fascinated by the
concept that if you counted cards, you could beat blackjack in Vegas. When I
became involved in the market I quickly started to see the parallels between
games and the market, in a probability sense. It was quite refreshing when
material started to become available that looked at trading from a probability
Before I discuss the probability aspects any further, let me
digress a little bit. When you look at trading educators, you see a whole
variety across the spectrum. I see many who never discuss losing trades at all.
They tell you all about how to get into a trade, techniques they recommend, and
even when to take profits. But they act like losing is not even something to
I have actually heard some say that that kind of negative thinking
will ruin your trading. I remember one educator who said he had something like
three hundred and fifty option trades in a row that were all winners. Now, I'm
not going to say that he didn't have that many. From a probability standpoint,
where fifty percent winners is quite good for options trading, three hundred
and fifty in a row is an unreal run.
But that's not
my concern. My concern is, if you claim that you made three hundred and fifty
trades in a row that were all winners, what would even be the point to spending
any significant amount of time teaching how to deal with losers, since they are
either non-existent, or pretty nearly so? I learned early on to run as fast as
I could from such educators.
Next, you find educators who do discuss the losing side
of trading, and do quite a good job. They tell you how to set stops, and how to
develop a plan. If the plan is a good one, it makes money overall. Some of the
better educators will work in probability aspects and better the education that
they are providing. So far, so good. Then what's the problem?
Just when you think
they got it right, they say something that blows it all for me. They say
something that shows me that they missed the whole point. Something that you
will probably read five times and then say 'I give up, it sounds fine to me,
what's wrong with that?' And that something is simply 'Okay, you were wrong on
that trade, cut your losses and get out. Admit that you were wrong, and move
on. Everybody makes mistakes.'
Here's where I hear that game show buzzer go off that
tells you that you just gave a wrong answer. I know, I can hear you now, just
as I predicted, saying 'Wait, there is nothing wrong with that, I read and
re-read it and it's fine.' Sorry, but that's just not the case. And if you
aren't fully convinced of this by the time you finish this article, you
probably aren't going to agree with very much of the Kane Trading philosophy.
Let me explain what's going on here.
When you enter a trade, you have no way of
knowing what the future holds, unless you are a true clairvoyant. Let's assume
that we are all more normal, and skip that possibility. If you can't know the
future, why would you trade? There is only one reason to trade, period.
You believe that the trade has a net positive expected value. In brief layman's
terms, that means that over time the method will make money.
It doesn't say that
any given trade will be a winner. In fact, over time it will have some
percentage of winners and some percentage of losers. But the total winnings for
the winners will exceed the total losses from the losers, netting you a profit.
Hence, you have a 'positive expected value'. These are very basic calculations
from probability theory, and can be quite useful in trading. I have written an
article on expected value in relation to profit taking, and I may post it on
the site at some point, as well as write some other articles down the line on
Here's the point. The decision to trade the given signal is that,
overall, it makes money. It has winning trades and losing trades. That is
normal. As long as it makes money overall, you are happy. Now this is right out
of many current, very good trading books on this topic. You can't know which
trades will be the winners and which will be the losers, all you know is that
you have an edge, a reason to believe that the net outcome will be
recent study at MIT finally verified that future price direction is not, in
fact, random, but can be predicted to some extent (what a shock!). That doesn't
mean predict every price movement, or predict with one hundred percent
certainty, but that certain setups can, in fact, produce an edge that is not
random. In other words, they demonstrated a net positive outcome for certain
setups. When I locate the actual study on the Internet I will put up a link
this, you know that you will be stopped out of some trades, and that some will
be winners. The fact that you don't know ahead of time if it will be a winner
or a loser is immaterial. In fact, it's a moot point to even point out that if
you knew which were going to be losers you'd simply not take those trades,
because if you could do that, we wouldn't even be discussing this. You'd have
100% winners, and you'd either be that clairvoyant we were discussing (and
running a 900 hotline on television), or more likely you'd be busy using all
your winnings to buy up all the islands that you could lay your hands
to reality, which is that all trading plans will have losers, and you'll stop
out of those trades. So far I'm sure you are with me, and maybe even wondering
what the point is, or if there even is a point anymore. Don't fret, it's
coming. Given that you have a winning plan and that you are following this
plan, and given that you can't possibly know which trades will be winners and
which will be losers, why in the world would you ever say something like
'I was wrong on that trade'?
You can be wrong if you don't follow your plan. If you
get emotional, and go off the track from your avowed mission, that's wrong. If
your plan, overall, is not a net positive outcome plan and you know it, but
still trade it, that's wrong. But if you follow your winning positive expected
outcome plan and stop out of the trades that, by normal probability, don't
become winners, you are in no way wrong!
In fact, you are as right as you
can be!! You are doing 100% exactly what you should be doing, and you should be
commended. Instead, you are made to feel like you screwed up (but at least you
stopped the loss, so they tell you that you aren't a total screw up). They will
make you feel a little better by throwing in an 'If it's any consolation,
though, hey, nobody's perfect, so it's okay that you were wrong.' To me, this
is not only completely inconsistent with trading using probabilities,
but is also very destructive to the trader.
I remember listening to one educator
explaining how to improve your percentage of winning trades, which I agree is a
great thing to do, and then completely blowing it when he got to the reason why
this is important. In a convoluted way, he explained that most people have a
lot of trouble admitting that they are wrong, and having to do so is very
stressful to most people. Hence, if you learn his methods you'll have a very
high winning percentage, and you won't have to admit to your brokers, family,
trading colleagues, etc. how you screwed up. To me, this is completely messed
my point is now eminently clear. And I think the difference in how I approach
this business should be starting to become clear to you. If you agree that the
point is not only clear now, but quite a significant point, then you're likely
hungry for more Kane Trading style material. If you are thinking 'Ah, that's
just a semantic word play, it doesn't matter', then you missed the point
completely, and probably won't care much for my work. I'm not saying just click
off my site then, but I am saying perhaps re-read this article and see if you
can get the concept on another go-round.
If you don't see trading in probability
terms, I feel that you will make your trading much harder than it has to be,
and you will reduce your chances for success. If you agree with this, then you
can see that if you are constantly thinking you are 'wrong' in trades and
'right' in trades, you are not thinking in probability terms.
If you are
following educators who seem to have it all correct except this one aspect,
perhaps it might behoove you to reconsider how right they actually have it, if
this simple idea eludes them. I'm not trying to slam any other educators; I'm
only trying to point out some things to look out for. I'm trying to help you
evaluate the value of the material that you might be coming across. I'm trying,
as I state in my mission statement, to provide some of the critical advice that
I wish I could have found when I first started.
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