Simple Statistics

Simple Statistics

Do we as discretionary trader control everything? def not.
But how much do we actually control?
By math, less than we’d like and more than we think.

Learning to trade is an emotional rollercoaster. It is a true test of someone’s character and makes a person search deep inside themselves to find out whether they really have what it takes. One of the essential qualities developed by master traders is the ability to stay calm under pressure, allowing them to make the right decision, devoid of emotion. There is no better time to evaluate one’s skill in this department than when you are facing a losing trade. The reason why it is so hard to make the right decision in such an instance is because it goes against our human programming and the subconscious reactions (fight or flight type reactions) we have evolved over thousands of years.

Studies have shown that people are statistically more than twice as emotional when they lose 100€ as they are when they make 100€. Trading involves markets that trade in bands of extreme volatility (witness the German Bund today!). You will often find yourself onside and then offside repeatedly in a short space of time. Combine these market conditions with the fear of losing money and you can see why people prefer to hold on to their losers as opposed to cutting them, even when they know they are wrong. It also makes sense why traders want to take profit as soon as they are onside instead of running their winners.

Common statistics provide a very good explanation of why this practice cannot succeed in the long run. Statisticians suggest that trading is a 50/50 “bet” on whether a price goes up or down. In reality, many markets will only trend 20% of the time and actually go sideways for the remainder. If we were to execute 100 trades then statistically we would have 80 small winners or losers cancelling each other out. We would also have 10 big winners and 10 big losers. So, if a trader cuts all of his winners short by taking profit and yet runs all of his losers through fear, then we now have 10 big losers and 90 small winners/small losers making it impossible to make consistent profits, no matter how good a trader you are.