How to Trade With the Odds In Your Favor

Trading when the odds are in your favor is trend following. Trading with the odds against you is gambling.

Many of the same people that think trading is gambling or that the options, futures, and stock market are too risky are the same that will not hesitate to buy a Powerball ticket, scratch of f a lottery ticket, have a fun weekend in Las Vegas, or fill out an NCAA March Madness bracket for a contest. They do not understand the odds. According to Wikipedia the odds of hitting the winning Powerball numbers is 1 in 292,201,338 per play. That’s over 292 million to 1. Millions of people play it. States take in billions of dollars from the losing players and no one bats an eye. State lotteries are using players hope and greed to make a fortune based on the sound math of their games. Every time a lottery player loses the state wins, and they lose most the time. The lottery is the casino and the lottery buyers are the gamblers. How could Warren Buffett offer a $1 billion prize through his subsidiary Quicken Loans for anyone who could pick a perfect NCAA basketball tournament? At first glance it would seem someone could do this and Buffett would be out $1 billion. It is just a basketball tournament isn’t it? However the math shows the odds of anyone picking a perfect bracket at anywhere from 1 in 9.2 quintillion, while others, including Jeff Bergen, a professor at DePaul, think it’s as ‘easy’ as 1 in 128 billion according to the NCAA website.

The mathematicians can’t even agree on the odds due to the complexity of the bracket system and getting every game right then the sequence right after each underdog creates an upset win. With those odds basketball fans still fill out brackets and enter contests with the belief that it is possible that they could get their whole bracket right. Some of these same people look at traders like we are just gamblers. The best trend traders are not the gamblers, they are the casino that wins the money from the traders that are there to simply gamble or hedge a position.

Traders that trade randomly based on their own predictions, opinions, tips, and egos are just gambling. They do not posses any edge over randomness. A trader with a tested trading system and a plan to execute their system with real money in real time price action starts to operate like a business. Consistent entry and exit signal executed consistently with discipline over a long time frame starts to separate you from the gamblers and the gamers. Short term trading results can be random it takes time for a trading edge to play out. One really good trending market or stock can make your year or even quickly compound your trading capital. Trend traders are not trading to pay their monthly light bill they are in it for the long term to compound their trading capital into a life changing amount.

Considering the math trading is very simple. With each trade entry you have a 50% chance that the market price trends in the direction of your entry on its next movement. It can only go up, down, or stay the same. From your 50% odds based on randomness then you will attempt to get the odds in your favor by going in the direction of the predominant trend in your time frame. The odds are generally in favor of a trend continuing than reversing as a market is under buying pressure or selling pressure. Trends can continue for months or even years while tops and bottoms happen only at the beginning or the end of a trend. A trend trader has one edge by simply going with a trend in price action and not trying to call tops and bottoms over and over again and instead profiting from the majority of the trend. Trend following price action is an alternative to participating in the randomness of trying to make buy and sell decisions by calculating fundamental valuations in the hopes that the market will agree at some future date. Or trying to predict a non-existent future based on an opinion that contains no edge.

Larry Hite explains that everything revolves around having an edge in your trading. If you have an edge and if you keep making good trades as opposed to betting on luck then over time you will make money. What kind of an edge does a trend trader have in the markets? The trend is the direction of least resistance. Commodities can have price trends that last months or longer.  In the stock market the underlying trend of the market accounts for a great percentage of a stock’s individual performance. If a stock is at all time highs and has no overhead resistance and the trend of the underlying sector is up this increases your odds for potentially strong and explosive moves. Breakouts from price ranges can be a signal that a strong trend has begun. To simplify trend traders in the stock market are bulls in bull markets and bears in bear markets, not based on their opinions but based on the price action they are seeing. This sounds simple but there are many traders who do not profit from bull markets because they disagree with the move for some reason. Buy and hold investors hold their stocks during bear markets and continue to buy because that is their system. Everyone is not a bull or a bear at the right time except the trend traders.

Blackjack and poker are some of the only gambling games found in a casino that are not determined by chance alone. The shrewd player can influence the outcome by counting the cards and using a system. The fact that most casino visitors unconsciously aim at losing or play for the thrill creates chances for the rational gambler, the one who sits down poised to win. The key is to have the odds on your side and bet properly. The same goes for trading. A former student of Richard Dennis once said:

“When you are invested properly, money management is relatively simple. [We] adjust trading size for profits and losses using Richard Dennis’ model for volatility. No trader can control volatility completely, but you can improve your odds.”

In trading your stop loss is like the fold is in poker. You give up your small ante into the pot when the quality of your dealt hand does not favor you with the odds of winning. To press a losing hand and bet more is expensive in poker and in trading.

Improving those odds or getting at the probabilities is central to any trend following trading system. Pierre Simon knew and wrote about this concept in his book, Theorie Analytique des Probabilites, back in 1812:

“It is remarkable that a science which began with the consideration of games of chance should have become the most important object of human knowledge. The most important questions of life are, for the most part, really only problems of probability.”

What else do winning players in poker and blackjack and great trend followers have in common?

More than you think:

  1. They are in business: Successful players and great traders pursue their goals as a business, not as a leisurely pursuit. From blackjack to poker to trading, making serious money demands they get serious. As a result, the winners take a completely different approach towards betting from people who play for the action, the excitement and, of course, the dream of winning big. Successful traders put in the time to learn what leads to profitability. They manage their risk and look for a structure of entry and exit signals that will lead to profitability.
  2. They keep records: People, who are successful at either trading, poker, or blackjack keep detailed records. Keeping records builds confidence and discipline. You are keeping a journal of your decision-making of when, where, why and how much you bet on each trade or wager. The idea is to reach a comfort zone for yourself and stay within that zone whenever you are tempted to leave it, which will happen, we assure you. Keeping records is a part of managing your money, and if you are not disciplined in your money management, you are going to lose your entire bankroll. You can manage, change, and improve on only those things that you track. A trading journal is a tool that teaches a trader about themselves.
  3. They are calm, cool and collected: To become even-tempered about money takes practice. You must force yourself to detach. You want to create an abstract money world where profits and losses are viewed in terms of abstract dollars. In this abstract world you don’t get excited about profits and you don’t get down about losses. You don’t want your emotions to go up and down with your account equity. If you can’t control greed, fear and hope — trading might not be for you.
  4. They are running a marathon: Successful poker and blackjack, like long-term trend following is a marathon. If you try to sprint, you’re going to lose the race. It’s just business.

There are two types of risk: blind and calculated. The first one: blind risk is always random in nature. Blind risk is taken with little if any understanding of the odds of success. Blind risk does not take into account the risk of ruin or whether the risk is worth the reward. Blind risk is can come from laziness: the irrational hope, getting something for nothing. Hoping for a twist of fate or winning the lottery are examples of blind hope leading to blind risk. Blind risk is the pointless gamble, the emotional decision, or the sucker bet. The person that embraces blind risk never wins in the long term. However calculated risk can build wealth, countries, and business empires. Calculated risk and bold vision go together. To see the probabilities, follow the logic and reason, and to move forward in confidence is how you win in anything that you pursue. Calculated risk lies at the heart of every achiever and great achievement throughout human history. Trend traders are profitable long term because they thrive on taking calculated risks and collecting their rewards.

Trend Trading Tips:

  • Trade in the direction of the trend in your timeframe.
  • Only trade using a tested winning system.
  • Only take systematic entries and exits.
  • Only trade a predetermined position size within your risk parameters.
  • Follow your system with discipline.

Bottom line: Trade smart with the odds of long term success are in your favor.