Sunday, September 12, 2010

The Gambler’s Fallacy

“The human mind is not wired to trade properly. Our decision-making process is not like most other animals. Most people don't focus on reality when deciding to take action; we make decisions based on emotion, not intellect. Not only is it very difficult to live in complete reality, but consistently making actions based on reality is an even harder task many times. A goose, on the other hand, would make an excellent trader and investor. When autumn approaches in the north, the geese don't wonder if winter will come or not. They certainly don't call a goose meeting to figure out a way to stave off winter. They simply act like a machine and fly south for the winter and repeat this process each and every year flawlessly for their entire life, without questioning their choice.” --- Sam Seiden


If you’re considering a career in trading, you need to accept the fundamental fact that trading is simple, but far from easy. You need to concentrate on the principles that guarantee long term survival on the markets and love them like your mom. I know that coaching people to reach their trading maximum requires understanding them. The trading coach has to help them develop their strengths and maximize their weaknesses. He needs to inspire them to carry on and reach their trading potential.

It’s true that the best way to improve your trading skills is to consult and expert on the subject and then apply the advice he gives. However common sense should tell you the difference between someone telling you lies and someone telling you the truth – unless you’re innately avaricious. As the saying goes, if it’s too good to be true, it probably is. The easiest way to scam a person is to appeal to their sense of greed. Someone who’s level-headed and not greedy would be very difficult to swindle.

The kind of training you received or information you were exposed to at the beginning of your career will have a great impact on your trading results. Did you get your strategy from a vendor who encourages high risk for profit maximization? Did you get trained by a marketer who was capitalizing on your ignorance? There are some seeming trading experts who managed to build reputation fro themselves in the past, and are now using their reputation to deceive people. People invariably tell me of a Forex man who’s very popular. He often advertises Forex training and products on radio, television and in newspapers. It’s true he won an online trading contest in the past. He’s already become a household name. I always appreciate and admire those who’ve taken it on themselves to help people achieve consistent profits on the markets. But I draw the line at deceiving people for the purpose of taking their money. What’s totally strange is that this man trains people only for 2 days – Saturday and Sunday, with only one-week after-training consultancy! What kind of thick-skinned wickedness is this, training people when the markets are closed, training people for 2 days only when those who’ve been at it for years still face challenges? Doing training when the markets are closed is like training people how to swim on dry land. If the person finally goes to the ocean, they’ll get drowned and eaten by sharks. He wants to encourage those who don’t have time during the working days to attend. As far as I’m concerned, if you got no time for trading you shouldn’t think of trading at all. Trading isn’t compulsory; it’s a matter of choice. Many people throng to him because he assures them that they can make 10% or 20% returns on daily basis. If he were making money like that, would he need to advertise or beg anybody to come for training? Why hasn’t his myth been burst? If a former trainee of him experiences a failure on the markets, he keeps the experience to himself and nurses his own wound in silence. When deciding about getting trained, people look at how rich and well-known their potential coach is rather than how skilled he is. No wonder Forex is unpopular.

It’s a gambler that keeps on looking for Holy Grail despite the fact that such doesn’t exist. It’s a gambler that goes for a short-term training without using the common sense that any worthwhile skill takes a long time to master. It’s a gambler that neglects money management and trading psychology and finds it difficult to control his emotions. It’s a gambler that hopes to reap where he hasn’t sown. It’s a gambler that thinks each trade should be a winner. It’s gambler that risks high with the hope of winning a jackpot whereas real investor goes for small but consistent profits (if I can get 5% profits on monthly basis, them I’m OK).

On Wednesday, I’ll show you how trading geniuses and mavericks react to their trading results; something you can benefit from. And on Friday you’ll be introduced to a touching concept that can make you measure the viability and effectiveness of your trading strategy.

Below is another instance of the gambler’s fallacy; an example given by Dr. Van Tharp:

“How can you lose money in a 60% system with one-to-one payoff? In a 60% system, you’re likely to have seven or eight losses in a row during 1000 trials. But you could easily have five losses in a row in such a system during a 50 trial run.

Let’s say that we’re about to start such a streak and you’ve adopted a strategy of betting 10% of your equity. For the sake of simplicity, let say that your stake when the losing streak starts is $1000. You begin by betting 10% or $100 and you hit the first loss. You now have $900 left. You decide to bet $90 and you have another loss. You now have $810 left. After the third loss, you decide to bet $81 and you have your third consecutive loss. You now have $719 left. At this point, you thought process might be the following; “We’ve had three losses in a row and we’re really due for a win now. After all, this is a 60% system. I think I’ll risk $300 on this one.” Now you get loss number four and you only have $419 left. You feel desperate. You’re down almost 60% in just four trials. You think; ‘we have to have a winner now,” and you decide to risk another $300. Loss number five comes up and you’re down to $119. You now have to make nearly 900% just to make up for the losses on the last five trials and your chances of doing so are very slim.

Some of you might be thinking, you should have waited until the five losses in a row and then bet $300. If that’s your thinking process, you have the same problem like the original trader. It’s called the gambler’s fallacy. Your chances of losing on any given draw are 40%. They have nothing to do with what happened in the past. When you think that way, just as you bet $300, you’ll have the sixth straight loss.”

Your questions and opinions are highly welcome.

Thank you.

With best regards,

Azeez Mustapha
Forex Signals Strategist, Funds Manager &Coach

Senior Analyst
FX Instructor, LLC

Yahoo! Messenger ID: saazalmu

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NB: There is risk of loss in trading, but it is possible to be a successful trader.

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