Trading is about probabilities not predictions



In my experience many of the people that start out learning to trade futures feel that there is a comparison between futures trading and casino gambling.  The definition of gambling is the wagering of money or something of material value on an event with an uncertain outcome. This “uncertain outcome” is the key phrase in gambling. Gambling also tends to have negative connotations and to be called an addiction or a habit and is generally not looked highly upon.

This is not the case with trading. Trading is a legitimate business and many people make a significant living trading futures. Futures are also a form of investing in the short term moves of commodities. In many ways there are similarities between trading and gambling, but one of the major differences is, a skilled futures trader will be taking the position of the house and not the gambler.  The skilled trader will always trade a system. He or she will faithfully follow the rules of the system. They will trade as a job and not let emotions change their methods.  Anyone that has spent any time in the casinos knows the house always wins in the end, because they follow the rules.

In finance, trading is described as an exchange of a security (stocks, bonds, commodities, currencies, derivatives or any valuable financial instrument) for "cash". Both parties seek to derive value from the trade. Some traders think this makes trading is a zero sum game where someone has to lose in order for someone to win. On a macro scale this may be true, but this is not true for the professional futures traders.

For an example, as the trader assumes a new position on a futures instrument in the market, he or she may be relieving someone of their profitable position. At this point the trader may go on to make even more profits out of this futures instrument. This scenario may continue on and on for some time. At some point in trading a poorly executed trade may be made and loses may occur. Generally this happens when the market unexpectedly shifts directions and traders move out of positions so as not to expose themselves to even greater loses. This result can be, but is not always part of a trading system. Most trading systems will have an acceptable lose ratio. The unacceptable loses occur when inexperienced traders or traders not following a system exit early from the trades in losing positions.  These loses are mostly driven by emotions.

A quality trading system is based on statistic and probabilities.  An experienced trader will look for signals to enter and exit trades. These signals are tested and based on quantifiable information that has been compiled over a long period of time. These trading signals or indicators will have safeguards built in. These safeguards will be targets, stops and limits and rules surrounding every action the trader makes. A quality trading system will also have probabilities attached to the actions.

The trading systems rules will cover all scenarios and have contingencies built in for all unknowns.  These rules are composed of pre-determined targets and stop losses, timeframes and many other criteria. There will be variables in the trading system and they will be documented thoroughly and specific actions will be followed based on the variable.

If the trading system is performed accurately without mistakes there is an anticipated outcome or probability. This outcome will achieve profitable results consistently. Following the rules of a trading system is not gambling.

As a simplistic example of a system similar to what is used in trading, would be to take the coin flip game, heads or tails. The guaranteed outcome of this exercise is 50% heads and 50% tails. If a player chooses heads every single flip of the coin, what are the outcome probabilities? They can only be 50%, so if the player chooses heads every time it’s not gambling. The maximum target is always achieved.

So how does someone win at this game? The easiest way to win would be to adjust the payouts to one side of the coin and maintain the system as it becomes profitable.

Obviously trading systems are more complex and there are multiple facets to trading, including the system itself, the mechanical actions and requirements of the trader are equally important, and the inherent human nature to change the rules based on outside influences is one of the hardest parts to overcome.

As you can see from what has been written trading is about probabilities. If you stick with the system consistently by following all the rules, you will have consistent results. Remember, trading should not be gambling.