Gambler or Trader? Trading Turmoil.
Stockscores.com Perspectives for the week ending June 27, 2016
In this week's issue:
In This Week's Issue:
- Stockscores' Market Minutes Video - When to Buy Panic
- Stockscores Trader Training - Gambler or Trader?
- Stock Features of the Week - Trading Turmoil
Stockscores Market Minutes Video - When to Buy Panic
When is it time to step in front of panic selling and buy stocks? This week, I describe some of the things to look for. Click Here to Watch To get instant updates when I upload a new video, subscribe to the Stockscores YouTube Channel
Trader Training - Gambler or Trader?
Many people think that trading the stock market is a form of gambling, making the markets of the world not much more than giant electronic casinos. For many who trade the market, gambling is exactly what they are doing. For others, trading is not gambling and this week I want to outline what makes the difference.
First, let's define what gambling is. Simply, it is wagering money on a bet that has a negative expected value. That means that a rational person who understands the odds of the bet should expect to get less back than they put in. Yes, a gambler might get lucky and get far more back than the math would predict but placing these bets many times will lead to losses.
To avoid being a gambler, the trader must make trades that have a positive expected value. Let me explain by looking at a well-known casino game, Blackjack.
The object of Blackjack is to amass cards that add up to 21 without going over with the hope that your total is greater than that of the dealer. The player who has a King of Hearts and a 10 has a score of 20 and beats the dealer if she has a pair of nines, adding up to 18. I am sure you already know how the game works and I expect that most of you know that in Blackjack, like any casino game, the odds favor the house. That means that a casino that deals thousands of hands of Blackjack can expect to win. They won't win every hand, just the majority over a large number of hands.
Therefore, Blackjack is a gamble because the expected value of playing the game is negative. There are, however, ways to take the gamble out of Blackjack, some legal according to the rules of the game and others not.
If the dealer is showing a six and you the player have a six and a five, it is not a gamble to "Double Down" by doubling your bet and only taking one more card. The odds of you winning are in your favor in this scenario because the six that the dealer holds is a bad card and the 11 that you currently have has a good chance of turning in to a 21 if you draw a card that has a value of 10. Doubling down on 11 has a positive expected value as long as the dealer is not showing an Ace.
So, within a gambling game like Blackjack there are scenarios where the odds favor making a bigger bet without breaking the rules. Some Blackjack players have learned how to break the rules of the game and put the odds in their favor, the most common way is to count cards.
A card counter keeps track of the number of face and small number cards that remain in the deck by counting those that have been dealt. When a remaining deck is heavy with high value cards, the odds of the player beating the dealer goes up enough to favor the player, making the game one where the expected value of making a bet is positive. At this point, the game is no longer a gamble because the player should make money, unless they suffer from bad luck. This differs from the gambler who relies on good luck to win.
Let's bring this concept back to trading. Do you know the expected value of the trades you make in the market? To really understand what your odds of making a profit, and the expected size of that profit, requires establishing a set of rules and testing those rules over a large number of trades so you can determine the expected value of your strategy rules.
You may establish that you want to buy any stock that a PE Ratio of less than 70% of the industry average. Sounds like a good idea, but is it? Only testing that rule over many trading examples and market conditions can really tell you if this simple approach to the market is an effective one.
Strategies do not have to be complicated by they do need to be well tested. If you approach the market without a set of trading rules and an understanding of the expected value of your trading approach, you are a gambler. Yes, you will get lucky and could make great profits. However, in the long run, the profits of the gambling trader are just short term loans.
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With Brexit still large in the rear view mirror, we have lots of uncertainty which means lots of volatility. While most consider this to be a tough time for the market, it is a great time to be a trader because volatility and emotion is how we make money. Here are the two trading vehicles that I use the most during times of market turmoil.Back To Top
1. VXX
VXX is the most liquid ETF based on the Volatility Index (VIX). This index reflects the implied volatility priced in to the S&P 500 Futures. The more traders of these Futures contracts expect volatility in the future, the more they will pay for them. This means that in times of uncertainty, like market corrections, the VIX will move higher and so too the VXX that tracks it. I love to trade this when there is high stock market volatility. Alternatives to it include UVXY, TVIX and T.HVU.
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2. XIV
XIV is the inverse of the VXX, it will tend to go up when the market goes up but is only worth trading after the VXX has been hot and then starts to cool down. Rather than short the VXX, buy the XIV. Canadian listed alternative is the T.HVI.
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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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