One of my biggest pet peeves in this business is that of traders constantly
searching for that perfect system, newsletter, or so-called “guru” that will
catapult them from failure or inconsistent performance to immediate and
consistent profitability, when no such thing exists. As such, one of the
industry myths I wanted to address as a prelude to setups was the following:
So what’s the big deal about probability? Well, I strongly believe that
success in trading is far more dependent upon the understanding, acceptance and
application of probability principles than any other facet. While the concept of
probability may seem simple and reinforcing for some traders, grasping and
making probability do the work for you remains a strong challenge for many who
continue to struggle in their trading journey.
The Uncertain Future
One indisputable fact in this, or any other business, is that no one can
predict the future. While this point may seem ridiculously obvious, let me
repeat it for emphasis — no one can predict the future. As mere mortals, we’re
all trading on what many have called the “right side of the chart,” and neither
I, nor you, nor the top traders in the world can tell you what the market will
do in the next minute, hour, day or week. And while it might seem unimaginable
to think anything less, many emerging traders seem to spend day after day
searching for that Holy Grail, crystal ball, analyst, stock caller, or other
device that will rid them of the requirement to operate in an environment of
Perhaps you’ve seen traders who take great pride — perhaps even boast — of
their ability to accurately “predict” a market’s movement. Or perhaps you’ve
gotten personally frustrated over a trade entry because the market moved in the
other direction, leaving you with a feeling that you were “wrong.” Yet since no
one can predict the future, how can there ever be a right or wrong?
Chest-pounding or perceived trade “failures” are clear cancers in this business,
as uncertainty prevents there from ever being a right or wrong.
One interesting note: Having worked with dozens of emerging traders over the
last few years, as well as looking back at my own development and evolution from
the corporate life to the trading profession, two particular backgrounds come to
mind when I think of traders who struggle to operate in the realm of
uncertainty: engineers and accountants (including myself). Why? Because
individuals whose strengths may shine in such specialized fields that require
constant precision will often struggle when attempting to operate in an
environment absent of equations, logical formulas, spreadsheet footings, and the
So how do we begin to overcome the challenges inherent in an uncertain
environment? The answer is to see a simple bias that skews probability in one’s
favor over multiple trades.
Seeking A Bias
Many folks have commented on my rather “simple” view of the market. As I’ve
noted in the past, I use just three indicators in seeking trade entries: One
determines trend (moving averages), one defines momentum strength (stochastics),
and another defines a trading range (Bollinger bands). That’s it. Three. And one
of them (MA) is about as basic as one can get.
So why would I choose a rather simple and mundane approach to the market when
there are multitudes of other indicators available? The answer is that I’m
simply attempting to leverage off historically repeatable pattern biases whose
only function is to skew probability in my favor over time. I view such an
approach as analogous to flipping a rigged coin (one that is unfairly weighted
toward heads) time and time again. We know that the result will be heads much of
the time, tails occasionally — including periodic consecutive attempts — and
we really don’t care if any particular toss comes up heads or tails.
One of the main reasons I encourage newer traders to focus on a single
market, such as the QQQQ, is that doing so fosters a suitable environment where
trade probability takes precedence. By executing multiple trades of the same
commodity, equity or market — using a constant pattern, trigger and stop
mechanism — that results in a favorable outcome more times than not, sample
size, time and probability will essentially do the heavy lifting. In fact, while
top traders continually seek a bias, many will operate successfully even without
such a bias.
Why Win/Loss % Can Be Irrelevant
Over the years, some have asked for my views on an appropriate win/loss
percentage on a trade-specific basis. My response is that while such a
percentage may be a valid measuring stick for certain traders and methods, there
are many styles for which the win/loss concept is a totally irrelevant tool —
and potentially dangerous, if it places focus in the wrong area.
For example, an intraday trader who prefers to have a position in the market
to catch a critical anticipated move can have a ratio far less than 50% and be
highly profitable, as is indeed the case for many world-class traders. Consider
the following trade sequence for an intraday scalper:
1. An initial QQQ pullback entry as the market approaches trend support,
followed by an immediate trade scratch when changing market conditions render
the premise for the entry invalid for a net of $0.00.
2. A re-entry based on a similar premise of the market holding key support,
followed by a $0.10 stop when support fails; and
3. A final re-entry upon the market not following through on the trend
reversal, followed by a profitable $0.50 exit. In this case, the win/loss % was
a mere 33%, with net profits of $0.40.
Now let’s do a quick reality check on that sequence.
Is the sequence unrealistic? Not at all, as such a trade-management
plan reflects a successful blueprint for effective trading for many, including
me. Specifically, positioning for trend reversals, such as those reversing via
“cup-and-handle” breakouts, often requires such a style.
Is such a concept only relevant to intraday scalping? Absolutely not.
Consider the unfortunate events of Sept. 11, 2001. Many will recall that the
Nasdaq was showing numerous signs of turning, just prior to the tragic events.
Significant price vs. stochastic strength divergence had developed on the hourly
chart, and lesser intraday trends had begun to turn northward. (If you recall,
we were actually gapping up early on the morning of 9/11.) Given the resulting
market dynamics upon reopening on 9/17, the subsequent downtrend extension and
consolidation from 9/17-10/2, and the final turn on 10/3, a similar entry/stop
(9/10-9/11), re-entry/stop (9/17), and final entry (10/3 when the daily trend
reversal triggered) with many opportunities for profitable exits, reflects a
very likely scenario which mirrors the precise sequence illustrated above.
Wouldn’t commission costs add up and offset the ultimate gain(s)?
Commission costs are undoubtedly a cost of doing business and will certainly
increase as trade volume increases. Yet, as commission rates have dropped
substantially over the last several years (in some case, 90% reductions from
$100 to under $10), the result has been increased profitability for this
While I’m certainly not advocating or encouraging hyperactive high-volume
trading, which clearly isn’t for everyone and will increase transaction costs,
the key concept is that of simply not missing the forest for the trees. If a
trader’s ultimate objective is the generation of net trading income over the
course of a month, quarter or year through the use of effective trade and risk
management, overemphasizing a micro statistic, such as trade-specific win/loss,
can result in misdirected focus for some.
Again, these concepts may seem startlingly obvious for some, yet why does it
seem that the concept of probability is so neglected and discussed so rarely
among trading circles? A few possible answers — that unsurprisingly, reflect
the general undoing of many traders — may provide clues:
Personal Ego — Many traders attempt to use the market to satisfy an
inner urge to prove themselves above others and are focused on being right,
rather than being profitable. While trade successes may very well appear on
occasion, consistent and lasting success will likely be highly elusive.
Pursuit of the “Thrill” — With hype ridiculously rampant in corners
of this industry, and with many pursuing trading for the perceived thrill and
excitement, such industry illusions can easily result in a misdirected trader’s
focus being 180 from where focus is necessary. Those misguided are often
eventually faced with making one of two decisions: (1) pursue boring consistent
profits following probability concepts, or (2) engage in the most expensive
thrill ride ever constructed.
Lack of Discipline — Effective use of probability requires a
disciplined approach, a trust in key probabilistic components, such as the
chosen pattern, and a recognition of a need to keep the pattern constant even
during times where the result of lesser probability may be occurring. Back to
our coin example, flipping that coin weighted toward heads, it may very well
land on tails three or four times in a row, at which point many traders would
simply move on to a different pattern or method and unknowingly remove a
There has been much written on the subject of probability, of which I’ve
admittedly only scratched a few surface areas. Yet I hope the perspective helps
to introduce (or reinforce for some) why and how probability plays such a
critical role in the business of continual uncertain speculation.
Don Miller is an active independent
futures trader and member of the Chicago Mercantile Exchange who focuses
primarily on the U.S. and Foreign Indices including the U.S. S&P E-Minis and
German DAX. In addition, Don has traded a private capital fund and served as
Director of Trader Development for TradeMaven Group.