Trading Probability

This is the simplest thing you need to know about Trading/Investment: You can’t guarantee a trade. You can only increase the probability of being correct. You are always essentially trading possibility. Trading possibility interest rates will rise. Trading probability other people will buy or sell. Trading probability that your bond issuer will last until the end of the repayment term.

Your goal is to maximize the probability you are right and minimize the probability you are wrong. This is the purpose of analysis and practice. You use risk management to control the size of loss to the maximum extent possible to avoid losing too much capital. This ensures that if you land on the wrong side of probability, you can still play the game. You eventually will and always can lose trades, since probability of loss is never zero. The equation is simply:

Where a win is having more money at the end of a trade and a loss is having less money at the end of a trade.

As you gain more experience, knowledge, practice, and quality analysis the probability of winning rises, approaching 100% but never actually 100%. It’s also never equal to zero. You could always do no analysis, randomly enter and randomly exit a trade and possibly still have a winner. But this is an inverted relationship, so as you do more analysis Probability of Loss falls.

You don’t control if you win or lose, that’s the market. You don’t control how much you’ll make per trade. You only control how much you can lose. This is where risk management appears. You can however make wins more probable over time by properly executing analysis before entering trades. This consists of Economic, Sector, Sentiment, Fundamental, and Technical Analysis. Studying, practicing, and executing each one will improve your trading.

Seeking alignment in analysis results will also increase your probability of success. Alignment means that your Economic, Sector, Sentiment, Fundamental, and Technical Analysis for an asset all give the same signal before an action. Your signals should be universally bullish before buying, or universally bearish before short selling. They should also preferably have an established trend in the bias’s direction. This improves the probability of your trades working out significantly.