Find the Edge
Stockscores.com Perspectives for the week ending March 30, 2008
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In this week's issue:
Do you know what is going to happen to the stocks you own on Monday? Can you go through your portfolio one stock at a time and describe how those stocks will finish the trading day? Up? Down? How much will they move? What would you rather bet $1000 on, your ability to make these predictions or your ability to predict what will happen to an ice cube left on the hood of your car in the middle of a hot summer day?
Expressed in these terms, all rational people will agree that there is uncertainty in the stock market, that predicting where prices will go is not a matter of science the way predicting how ice will melt is.
Therefore, we must all remind ourselves that the stock market can not be predicted.
Some of you will have trouble agreeing with this last statement because we think that we can predict where stocks will go, that is the reason we trade the market, to make money from our predictions.
But no one can predict the market with absolute certainty. Therefore, you have to stop looking at trading one trade at a time. Imagine what would happen to the casino owner who looked at their gambling business one bet at a time. The casino can not predict who will win the Superbowl or what the next card drawn in a game of Blackjack will be. And so, they don't try.
What the casino does, and what you as a trader should be doing, is trading the probability of what will happen. The casino makes money because they know what will happen over the next 1000 hands of blackjack. They can balance the odds of a football game in their favor. They have an edge.
The question is, do you have an edge in the market?
Are you trading a strategy that assures you a profit over a large number of trades? If you are serious about making money in the market, you should be able to define the expected out come of your trading strategy in the same way that a casino can predict their profitability from millions of dollars wagered in the pursuit of 21.
How do you calculate your edge? Simply:
((Profit of a successful trade times the probability of a successful trade) - (loss of an unsuccessful trade time the probability of an unsuccessful trade
As an example, a trade that has a 30% chance of making $5000 and a 70% chance of losing $1000 has an expected profitability of $800.
Here we see how even a trade that has the odds stacked against it is worth taking because it has a positive expected outcome. If you make this trade enough times, you will average $800 in profit per trade.
This means we need to set out on a study to determine the probabilities of profit and loss for a trading strategy. Establish a set of rules and then test them over a large sample of trades to determine the expected value of the trade.
But, if we find a trading strategy that has a profitable expected value, are we assured of success in the same way a casino is assured a profit hosting games of blackjack?
No. In blackjack, there are rules enforced by the casino. The player must give the casino their money if they go over 21. They must give their money if they have a hand that is lower than the dealer.
In trading, there is no one to enforce your well tested trading rules except you. In the heat of the trading moment, when you must decide whether to exit the trade at the stop loss point or hold out for a turnaround, it is only up to you. When you have the choice of selling for a profit or continuing to hold until you get the sell signal your strategy was tested for, it is only up to you.
And you, assuming you are a normal human being, are likely to break your own trading rules.
Why?
Because you avoid pain and pursue pleasure. You lack confidence in your strategy because of your recent experience. You think you can use your better judgment based on what you are seeing you now. You lose your focus.
These are the things that turn the relatively simple pursuit of making money in the market in to a frustrating, mind numbing and stressful process. Who is at fault?
Only You.
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The sellers continue to be in control of the stock market, making it more likely for stocks to go down in the future. With that downward momentum, short selling or buying Put options should be an easier way to profit than buying. This week, I ran the Long Term Breakdown strategy to identify some stocks that have a good potential to go lower in the weeks and months to come. Here are a couple of standouts:Back To Top
1. SOV
SOV hit a new closing low on Friday from a pessimistic descending triangle pattern. Although the stock is well off of its highs already I think this recent break through support sets the stock up for another leg down. Resistance at $10.90, a close above that would be a good reason to scrap the trade.
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2. KCI
KCI broke down through long term support this week and I think it has good potential to fall to $35. With resistance at $50 on the short set up, that gives a little better than a 3 to 1 risk reward ratio if the trade works out.
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References
Get the Stockscore on any of over 20,000 North American stocks.
Background on the theories used by Stockscores.
Strategies that can help you find new opportunities.
Scan the market using extensive filter criteria.
Build a portfolio of stocks and view a slide show of their charts.
See which sectors are leading the market, and their components.
Disclaimer
This is not an investment advisory, and should not be used to make
investment decisions. Information in Stockscores Perspectives is often
opinionated and should be considered for information purposes only. No
stock exchange anywhere has approved or disapproved of the information
contained herein. There is no express or implied solicitation to buy or
sell securities. The writers and editors of Perspectives may have positions
in the stocks discussed above and may trade in the stocks mentioned. Don't
consider buying or selling any stock without conducting your own due diligence.
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