The Difference Between Gambling and Speculating
Stockscores.com Perspectives for the week ending October 5, 2008
|
| Upcoming Events |
The Stockscores Canadian Tour
DisnatDirect presents the StockScores Canadian Tour for Fall 2008.
Toronto
Ottawa
Edmonton
Calgary
You are invited to hear Stockscores founder Tyler Bollhorn speak on his trading methods and how you can use the tools and education found on Stockscores to improve your own trading. Plus, you will have the opportunity to open a brokerage account with DisnatDirect and take advantage of the free StockSchool Pro offer.
For locations, details and to register for these free events, Click Here
|
| Get the StockSchool Pro Free |
DisnatDirect named the number one Canadian brokerage for Traders by Surviscor! Open and Fund a brokerage account with DisnatDirect and receive the StockSchool Pro home study course free, including special Pro level access through the DisnatDirect client website. Offer only available to Canadian residents. For information, click here
|
|
In this week's issue:
At parties, after small talk about the weather, conversation between people that have just met each other often turns to occupation. When asked about what I do, my answer must be an unusual one, for when I say "stock speculator" I often get a surprised look. I sometimes think that the look is not one of surprise but a fast attempt by the person I am talking with to cover up their true reactions.
I can imagine the thoughts going through their head,
"Oh boy, this guy must be a real dreamer … his poor wife, their life must be full of ups and downs … you should head to gamblers anonymous and get some help."
I can't blame them; I often have the same thoughts having met many people who describe themselves as stock speculators each time there is a bull market that proves their self described market expertise. In a market like the one that we have now the reaction has even greater merit, how could one possibly make a living trading stocks when everything is suffering like it has?
Most traders, whether working with stocks, futures or currencies, are gamblers. Their success is random and in the long run, their performance is not likely to exceed the market return. But there is a simple but important difference between a speculator and a gambler which all aspiring traders should understand and appreciate.
A speculator takes trades with a positive expected value, a gambler does not.
Of course, the gambler does not think they are gambling. They make trades with a real hope that they will profit from their moves. Time spent on research makes them feel they have justified their trading decision and made it a true speculation. But do they have any idea what the expected value of the trade is?
This concept is simple; the probability of being right multiplied by the profitability of being right minus the probability of being wrong multiplied by the loss from being wrong. If that value is positive, the trade should be taken.
Consider the game of blackjack, one that most everyone agrees is a form of gambling. The casino does not know what the outcome of any one hand of blackjack will be and nor do the players. Each hand could result in a win, a push or a loss. Each hand has an outcome that is unexpected.
But, the casino, with their understanding of probability, knows that the odds favor them. They know that if they deal thousands of hands of blackjack, they will make money because the odds favor the house by about 0.5%. And so, we see great monuments to the laws of probability growing out of the desert that is Las Vegas. The house wins.
It is possible for players to put the odds in their favor if they have the talent to count the cards and mask their actions (casinos have somehow been able to justify card counting as cheating and will kick you out if they discover you doing it).
The concept of card counting is based on the truth that the odds actually favor the player if the deck has a skewed number of high value cards. The card counter adds a point each time there is a small card and takes away a point each time a high card is dealt. When the count is high, the odds favor the player and he or she should make a heavier bet to take advantage of the shift in probability.
Expert card counters have made millions before they have been figured out. Their profits are due to the positive expected value when the card count is high.
The stock market is similar but with more dimensions. There are an infinite number of strategies that can be applied to trading, it is up to the trader to test a strategy for expected value.
If you test a strategy over a large sampling of trades and it yields a profit, then you have a set of trading rules that provides the potential for profit. So long as the market does not change in a way that prevents the rules from continuing to work and so long as you have the emotional control to follow the rules as you tested them, you can now move out of the gambler crowd and in to the speculator group.
It is not about being right or wrong, it is about how much you make when you are right versus how much you lose when you are wrong. It is not what you make or lose over a few trades, success can only be judged after you have made a large number of trades.
Which strategy would you pick?
Strategy A makes money 90% of the time. When it is profitable, it makes $500. When it is wrong, it loses $5000.
Strategy B makes money 10% of the time. When it is profitable, it makes $5000. When it is wrong, it loses $500.
A person in pursuit of an A in school aspires to be right 90% of the time, so they would probably pick Strategy A. But it is only Strategy B that has a positive expected value since, over 10 trades, it will make a profit of $500 while Strategy A will actually lose $500.
Stop gambling and find a set of trading rules that consistently makes you money over a large sampling of trades. Speculation is about understanding the laws of probability and knowing how to leverage them for profit.
Back To Top
Volatility represents uncertainty and in this way it is the trader's friend and enemy. Volatility makes the market more difficult to predict but the profitability of being right increases.
The market we find ourselves in now is extremely volatile and so it is difficult to predict. I do not think it is a good time to be a position trader, but because it is so volatile, short term trading is more profitable than normal. If you have the time and expertise to be a short term trader, you can do well in this market.
In that respect, I think there is a tremendous opportunity to play a bounce back in this market. It is not a long term trade; I don't expect the first phase of a bounce would last for more than a few days. However, because it is likely to be a volatile bounce, the profits should be good if you get it right.
Look for stocks that are down a lot over the last couple of weeks and have a very steep downward trend. These are stocks that are trading with some fear and are likely mispriced. On a bounce back, they should do well.
Below are just a couple of examples of stocks that I am watching, take these same principles in to next week for some good trading opportunities.
Back To Top
1. T.AGU
T.AGU has sold off very sharply but is now near long term support at $40. This makes it a likely candidate for a bounce but you must wait for a sign from the market that the bounce is beginning. For this, I look to the intraday, 15 minute chart. I want to see a break of the downward trend line on this chart or a break to the upside from a rising bottom. If this happens, enter the trade with your stop loss point at the inflection point low before the break. This set up will have a decent probability of success and a very nice risk reward trade off if it works.
Back To Top
2. T.SU
A 25% haircut on T.SU in only a few days makes the stock pretty oversold and due for a bounce back. Watch the intraday, 15 minute chart for a break of the downward trend or a break from an optimistic chart pattern. Put support at the bottom of the pattern and make sure you take the loss if the 15 minute chart closes below support.
Back To Top
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.
Back To Top
|
