A gambling thought experiment

Yeah. I know I keep bringing it back to trading, but it is SOOOO similar, not just in terms of your odds of competing based on fundamental research (or information), but in terms of money management. A rule of thumb, for example, that often gets recommended for beginning futures traders is that they don't risk more than 1 to 2 percent of their trading capital on any one trade -- because of those runs where you might have weeks where NOTHING is working. In the case of those futures, the leverage is so great that you can get wiped out easily if you are overlevered (and most don't realize they are).

Let's say you somehow have shifted your probabilities by doing something, so that over time, you now can expect to be right 60 percent of the time? You'd expect to make money over time. But there is nothing guaranteeing that over a relatively short period of time you aren't going to come up wrong several times in a row. And if you get wiped out because of it, you are victim to having been right in big the picture, but ultimately wrong because you didn't consider the little picture.

 

A Martingale model in gambling. ... is also known as "stochastics" in trading.

That is more along the way of how I think and operate -- although I don't use stochastics (have never found a consistent edge there. ... and you wouldn't believe the lengths I have gone to to back test several stochastic indicators!). Speaking very generally, stochastics tries to predict outcomes in random environments. I'd suggest you are way more likely to have success thinking about gambling THAT WAY. ... than you are thinking you can do better analysis than everyone else. Although, it's obviously not a simple thing to do either, and one that isn't likely to be successful either.

 

I'd make people's eyes glaze over more than I typically do on here if I posted all that I could say about this! But. ...

Have you ever been walking down the street and you saw a $20 on the sidewalk? EMH would tell you that the $20 shouldn't be there.

But it is.

EMH would tell you that Warren Buffett doesn't see unappreciated value. Or that Paul Tudor Jones didn't have an edge of some sort. They have just been incredibly lucky or they take on incredible risks (and have dodged bullets).

Is that really the case?

I believe in EMH in the general sense of how markets work, but not in any absolute sense. I believe that in that general way, something close to EMH probably explains why 99.9999 percent of us can't compete on fundamental research -- or information.

At the same time, I watch markets every day, very closely, and even though I can't prove it, I believe that there are behavioral factors (think crowd psychology) that influence price movements.

EMH would suggest that is nonsense.

I know from actually having put A LOT of money at risk, that making money is not as easy as simply knowing that crowd psychology is at work. I am not discussing this theoretically. Even someone who just has backtested various things endlessly, and thinks they have discerned something, isn't the same as a person who has money at risk. It all changes when you are sweating because a market is moving against you.

I believe (although maybe I am seeing what I want to see -- who knows?) I recognize that crowd psychology in action sometimes. ... but that said, I haven't found too many things that allow me to recognize and capitalize on anything in a systematic, non-discretionary way. Nor have I found a "system" or any way to easily make money.

Which is why whenever I talk to people who are looking to get rich quick, or who have never put their money at risk, I try to save them from losing what they have. I know there is no holy grail.

The only people I know who successfully make money at trading (I don't know as many gamblers) don't think about it as theoretically as I think you get to for a living. They just endlessly look for things that work more often than they don't work, and when they find something, they are incredibly disciplined in how they go about it. They're not as concerned with why it works, as the fact that it does work. And they are grinders, because the edges they believe they have feel miniscule. They tend to be defensive -- more worried about losing money than making money.

Not trying to be crptic, but most of the things that I have found "work" for me -- and I am successful -- would be too difficult to explain on here -- not because it's too complicated for others or because I am so smart, but because it took years of experience and noodling for me to get to where I am. I'd sound like I am speaking a foreign language.

What I can say, though, is that even though I can't explain why certain things work, I strongly suspect they relate to crowd psychology, and not just pure randomness. The things I have focused on (and that is because they work) make the most sense that way, at least.

But at a certain point, I am not that concerned with why the "trend is your friend," (I know people who have been successful using various momentum-related methodologies) or why most markets follow certain rhythms that lend themselves to swing trading. I'm just concerned with the fact that those things ARE true and by having a discipline in how I went about it, I have consistently bucked what EMH would tell you.

EMH would say I am lucky or taking way more risk than I realize (which is interesting in itself, because I am very focused on risk -- at least as I measure it by drawdowns).

Maybe it's true. . ... Or maybe it's not.