For beginners, get to know probabilities

If you’re a beginner trader then you will do well to understand what probabilities are and how they work, so you can trade and ‘think’ in probabilities. But it’s not easy to actually see and test this concept in a practical and simple way. Before I discovered the financial markets, I played around with sports trading for a short time.It’s not really necessary to explain here what sports trading is, but there are principles involved which relate directly to trading the financial markets.There are many different ways to trade and analyse the markets, but basically 2 types of trade execution, discretionary and systematic.  Systematic traders use systems or strategies based on pre-set rules and they execute trades following only those rules, algorithmic traders would also fall into this category.  Discretionary traders, even though they will have their own rules, execute trades based on their belief of what the market will do next according to their analysis of the market (more or less), they are more flexible in the way they trade and they may be more dynamic in areas of risk management etc.. I chose to be a systematic trader largely because of a website I stumbled across while I was doing research on sports trading. The website gathers all horse racing results data (bear with me….!) from the UK and Ireland and has simple tools which allow you to simulate placing bets on this historical data. I spent hours using this site, it drilled into me the importance and power of probabilities or ‘odds’, and it’s never left my mind. I am always looking for new ways to trade, new strategies, but they are always based on statistical probability and never on market prediction, you could also call it game theory. Knowing the statistical probability of my strategies gives me confidence, allows me to automate strategies, helps my psychology and emotional state, and means I don’t have to be watching the screen all day.Let me break this down a bit: Confidence - if you know through testing/stats for example what the longest expected losing streak is, then you remain calm when that losing streak happens. You expect it, you don’t think your strategy is broken or you need to change rules etc.. Automation - when your strategy operates with rigid predetermined rules then this can be easily automated if you wish. At the least it will save you having to constantly be at the screen because it can generate trading signals which you can act upon only when necessary. Psychology/emotion - this may sound strange but you kind of ‘know’ you’re going to win. You don’t know if the next trade will win, or the next 5 trades, but you know over time and multiple trades that your system has a positive expectancy. This will help keep you focused, calm, not revenge trade, not strategy hop, and keep you in the game. For beginners, I believe that being a systematic trader is by far the easiest route. And once you’re profitable trading in this manner then you can always try discretionary trading later on. The website I mentioned can be found if you Google ‘Adrian Massey horse racing’. It’s a really old looking site, quite funny really, and don’t try to use it on your phone….On the left hand side you will find links showing different kinds of analysis, choose ‘Odds analysis’, and then click on ‘Custom Report’.From there you can choose from hundreds of filters to simulate betting on horses of varying odds, racecourses, jockeys and many other inputs. This will generate a report showing the results of your choices. You will find that you can never beat the bookmaker!You will also realise how accurate the edge is in all the different odds, probabilities are power!. Of course this is sports betting and the odds are provided by the bookmakers, their edge is calculated into the odds, so you can never win long term. When you build your own trading strategies, you are basically creating your own edge, or your own odds, and you just need the odds to be in your favour long term.The results tables also help you get to grips with the very basics of probabilities, how risk/reward works together with win rate, and the corresponding variance and distribution of results. Understanding these principles is directly applicable to building and testing trading strategies and understanding that the long term outcome is not simply about win rate alone, or the outcome of a singular trade. Trying to ‘predict’ what the market is going to do next is something I think is a fool’s game in trading, but that’s a matter of opinion and not what this post is about. Using probabilities means you don’t have to predict the next trade, you don’t have to second guess yourself all the time, you only need to stick to your strategy and execute the trades as the signals appear. Have fun on the site, hope it helps 🙂 (the site uses fractional odds like in UK and US, while Europe uses mostly decimal odds, you’ll have to convert or learn if you don’t know how the odds calculations work)