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Wednesday, October 26, 2016

WHY PROBABILITY THEORY MATTERS


“Of course you already knew this … right?”
I’m gonna fill you in on a little secret only math pros [and by default certain professional traders who shall remain nameless] know; namely, probability theory & its slutty sister statistics aren’t what you think they are. For the vast majority of you, please take the following info too heart; “forget what you think you know about probability & statistics … what you think you know intuitively about how it works will cause extensive brain damage that will baffle you until you give up and eventually say … 'Who needs this shit anyway'?”

Well, to be brutally honest, you need this shit … and therein lies a big problem for Newbie traders & those that find themselves on the losing end of practically every damn trade they’ve ever made in their life. You can remember it as the “50/50/90” rule, depicted eloquently directly below.
“Kind of sums things up pretty well doesn’t it?”

When I used to live in Las Vegas, before I moved to “Paradise” down here in the Caribbean, I got to know some of the pit bosses who worked table games in the various casinos [“me gamble? … Ummmm, no … educational research only!], and the common thread which explained gambler’s behavior, that ran amongst all of them, were the following 2 factors; 1) “there’s a negative mathematical expectation on every play, so the longer you play the easier it is for us to win, so why would you think ‘luck’ has anything to do with it?, and 2) “you Sheeple that come in here to play really don’t understand how probability works, and how it is most definitely in our favor and not yours!”
When I meet and talk with people about trading & probability, I always like to show ‘em the following pic.


“Are you shittin’ me?”
And with that, the most common response among everyone not math inclined is “that’s impossible!” “Well, no it ain’t cuz it just happened … IT’S CALLED ‘TAIL RISK’, AND THERE ISN’T ANY WAY TO 1) PREDICT IT, 2) AVOID IT, OR 3) BET ON IT BEFORE YOU GO BROKE!" All you can do is PREPARE FOR IT IN ADVANCE. [Note: just so you know, the odds of this happening in roulette are about 1 occurrence every 137 years for the entirety of Las Vegas casinos.]

Now, some retard that just arrived from Mars, and fell off the turnip truck last night upon arriving would say, “hey, I see a pattern here … just bet on ‘19’ and make a fortune!” And of course, that pattern recognition on his behalf would have made him rich beyond his belief in this instance; only problem is hanging around one casino among the 30 or so that dot the landscape in Las Vegas and standing there 24/7 for the good part of 137 years he’ll get about a 3% shot at his pattern of betting. [“Please, don’t tell him this … it will just piss him off … and then Mars attacks!]
The “dirty little secret” of probability theory is that random events have 1) tail risk, and 2) show patterns that deceive humans into action where in fact no such patterns exist!
The general public, and traders in particular, have been educated in “modern portfolio theory” for the better part of 50+ years [and part of this is guys like me can’t exist! … “Go ahead, be brave, & tell that to the Mrs. when she goes to the ATM!”]; and that theory says markets are “random” and cannot be predicted; where the “problem” comes in is how you internalize this into how markets behave based on a binary event; namely, up or down like the flipping of a coin. It goes up a little, and now it’s time for it to go down a little. And in your mind you falsely set up probabilistic scenarios where this plays out; “Ok, time for this shit to go down some, so I’ll sell some” … only it doesn’t, it just keeps going up. And by the time it reaches the top, your emotions are screaming “This fucking shit ain’t ever, AND I MEAN EVAHHHH, going lower again” … as you pile in the long positions at the top. And now you feel like a “chump” and remember the “50/50/90” rule.
The problem, of course, should be plain for you to see. Your expectations on probability as it “plays out” in real time is faulty and just plain wrong; “please tell me how that translates you into a consistent winner for trading?”
The first priority of the volatility algorithm is to keep your ass out of trouble; no “tail risk” is ever going to affect my account balance as losses [when they eventually come] will be small and insignificant to my overall account balance. After that, changes in acceleration [momentum] put us on the short term “right side” of the market where anything and everything can/will happen when it comes to price movement; NO THOUGHT REQUIRED … IN FACT, TOTALLY DISCOURAGED WHEN IT COMES TO GETTING IN THE TRADE. Once the trade is on, and you’re up money … well, now you can start thinking [if you want] because you got a “free trade” on … you’re playing with profits not capital, and the only hard rules are liquidate on large above average spikes since the trade started, or most importantly liquidate at the exhaustion lines. But if the trade is “crawling” higher, you got some ‘wiggle room’ for thought. Just like I had yesterday.
Once you “get rid” of your thoughts on probability theory and “how” it should behave according to what has never worked in the past, it becomes much easier to let the visual algorithm take over and just follow it. I know; I walked this road many years ago and it was painful to make a living in the pits while the algo was “hittin’ home runs” practically every day. When I “submitted” to reality [after about 3 months] and cast away my delusions of how markets should trade … well, the rest is history.
I see last night Mr. Market took my message yesterday a little personal, and decided he’d “show me” and put in about a $14 range. “Good, about fucking time you got off your ass and did something. Can you do it again today, or was this a ‘one off’ and it’s back to the same old $8 - $9 range bullshit we been seeing the last 2 months? Well?” The not so good news for today? Well, the Asian chuckleheads traders didn’t sell it last night, and in fact tried to rally it more than a few time above 1277 without success; that probably translates into New York selling pressure at the outset. The question is, will we go for the stops above 1277 today, or later in the week after … maybe … a weak selloff followed by some more buying?
What I’d really like to see is a “flush the toilet” moment today, where the “Johnny come lately” crowd who are long get their sell stops hit off on a waterfall I can buy [hopefully at the exhaustion lines]; not planning on it but would like to see it.
Here at the open [08:00 New York time], a pretty much “bucket of slop”, with small $6 range for the day and the market sitting right on top of the daily calculated white horizontal line; equities weaker because of Apple. Will stock weakness on the back of Apple translate into funds moving into gold and higher prices? Don’t know … we’ll see. Maybe data at 9:45 & 10 will move something, cuz nothing ain’t movin’ now that’s for sure.
An hour into this and I’m wondering what fun it must be as the groomer for the bearded lady at the circus; uh oh, dog is sitting here staring holes into me.
 


“Hey you … yea, you … I couldn’t help but notice this morning you only had a bagel & coffee for breakfast … you gonna open the ‘impenetrable bacon box’ and get me something to eat or what? … dog food? … Whaddaya fuckin’ nuts?... you eat that shit … when do I get bacon? … I gots to know man!”
And all I have to do is look at him and act like maybe … maybe I’m getting’ up, and WOW! do I have his attention; “ever here of Pavlov’s dog mi amigo?”

Ok, here at mid morning, after the 2 reports are out … stocks have rallied smartly off their lows thus depressing gold, and it looks and feels like “chop city” going forward. One algo buy signal right before the reports came out I chose to ignore due to the closeness of the trade to potential market moving news; I trade, I don’t play roulette here, Ok? Potential for disaster is greater than any gain, so I ignore the signal in these types of scenarios … just makes sense to me.
Looks to me like the gold trade today is “over and out” and no trades; equities [read DOW30], that’s a different story. Volatility has picked up, and even with a 1.8 spread and a 2.8 index point “net cost”, this stuff is flying; reminds me of GBPNZD last year when it routinely had 300 – 500 PIP ranges every day; too bad the spread made it a “killer”.
And as you will see when the manual & tutorial for the DOW30 is released in a few weeks [cuz today’s action will be cataloged], the volatility algorithm just captured [here at 14:19 ASSETS FX server time – 10:19 New York & Paradise time] an approximate 65 point up move to the exhaustion line in 19 minutes. And just for the record, that’s a perfect square of price and time @ 45 degrees [diagonal cross]. “Ahhh, the wonders of Gann’s Square of Nine added to my proprietary vector calculus … I love the smell of … yea, you know the rest!”
“And yea, I know you don’t have the DOW30 manual yet and tutorial, and I’m sorry you missed the move … I’m working on it … I’m still finishing the gold tutorial, it’s a shipload of work … you’ll have both soon enough I promise!”
And if the DOW30 can keep up what’s it’s doing, then we in the U.S. have the very best of both worlds; gold in the morning, and if nothing is happening, shifting our focus to the DOW30, where plenty is happening until 4 PM New York time when it closes; that’s a full 8 hours of opportunity, where one or both should be flying.
Ok, money in the bank … “wait … what? … You think I’m smilin’ cuz I made a bunch of money? … no baby, I’m just happy cuz … whaddaya mean ‘bunch of shit’? … well, yea we all did ‘hit it’ a few minutes ago in the DOW30 but … ATM card?... what the hell? … where’s the dog when I need him for support? … he’s smarter than he looks … Ok here, try and think anything ‘low cost’ … bye.” Yea, thanks for coming to my defense fellas … just sit there like bumps on a log while I get frisked and robbed by the Mrs. for another “spa & lunch” day with the gal pals … “You’re buying lunch today.”
Easy come, easy go; all you married guys out there know exactly where I’m comin’ from … after lunch some Vitamin C therapy at the beach … until tomorrow … I’m sooooooo outta here!
Have a great day everybody!
-vegas
OPEN A DEMO AND/OR LIVE ACCOUNT AT THE LMFX LINK IN THE “DOWNLOAD LINKS” SECTION OF THE WEBSITE TITLED “OPEN TRADING ACCOUNT – DO IT NOW!”
 

 


 

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