BarroMetrics Views: Subjective Probability & Trading Success
The world that is being unveiled by Neurology fascinates me. It opens all sorts of possible avenues for better decision-making.
One of these areas is the human intolerance for ambiguity and uncertainty and yet both, ambiguity and uncertainty, are the essential conditions of the markets; more, they are the reason some are able to make a fabulous return from the markets.
The reason why the markets went into a tailspin last year was partially because the boffins started believing their own press: that Black Swans had been abolished, that the bell curve represented true trading probabilities; that subjective probabilities and objective probabilities are the same.
You only have to look at the foundation of economics to see the truth of those statements. Economics are predicated on the foundation that ‘HUMANS Act” - the key word is ‘humans’. And as humans. we are full of emotional foibles and uncertainties. Into this equation come the boffins with their Efficient Market Hypothesis and then wonder why the assumptions fall apart. Their folly is even more incongruous when you consider that any successful trader could have told them the EMH is wrong - they only had to listen.
The economic scenario finds their counterpart in the traders who confuse subjective probability with objective probability. Objective probability occurs when we say, for example, that in a six-sided dice, any one side has a 1/6 chance of occurring. That set probabilities is fixed and you can count on them being correct.
But if you say a trade has a 63% chance of occurring, that is an opinion. We are saying based on some idea (backtesting, experience etc), we believe that the trade has X% chance of returning a profit. But, there is no way of knowing whether this assessment accurately reflects reality. It is after all, just an an opinion.
In this environment, to trade without thought that it could prove to be a losing trade, lies the key to ruin.
Yet newbies persist on looking at a win rate rather than the Expectancy Return to assess a trading method; and they persist on putting their efforts on securing the ‘best system’ (no or limited drawdowns and high win rate under any and all market conditions); and they persist on believing they can turn $10,000 into$1M in two months without risk of ruin. And that is why 90% of newbies persistently fail.
Refer this blog post to a friend or colleague…
