Go with the Edge

Go with the Edge

Many people who have no knowledge of trading make the assumption that it is nothing more than gambling. But usually their definition of gambling is someone who takes unnecessary risks with money who have little chance of getting anything back monetarily and possess no personal discipline.

Although there are similarities between trading and gambling there are some very important distinctions as well. There are professional gamblers that have studied mathematically how they would have an edge if they optimally played a given game over a period of time that would allow them to have an outcome of financially gaining. Then there are gamblers who plan on taking a certain amount of their hard earned income and “win or lose” plan on blowing it all at a gambling facility adding to the lovely decors of those facilities. Trading also has participants from both sides of this coin. But let’s for the sake of this article assume that the gambling participant and the trader both have knowledge of how their games work. I will use the game of blackjack as the gambling example here.

Here are some important distinctions between the two:

The bets – In blackjack your bet is placed before the player has any idea of the probability of winning against the dealer. The total bet is the total risk unlike trading futures, commodities or stocks. Just think of this, if you could place your bet after your hand is dealt and the dealers up card is showing, do you think that might improve the outcome of the game for you?

In trading your bet is placed when it has been determined that you have an edge in the game and the probability of winning is on your side.

The exits - In blackjack once your bet is placed you can not take back any portion of it. You will win, lose it all, or push. If you see you have a high percentage of winning the hand against the dealer you can not increase your bet. There is no point at which you can take partial profits.

In trading once your bet is placed you have the option of limiting the amount of capital lost through stop loss protection, reducing the size of the bet. You can take partial profits, adding on if the trade moves in your favor or exit at a break even.

The distinction of not entering a trade until the odds favor you gives you a tremendous edge in trading, the ability to control the risk. Also being able to vary the bet by increasing it or reducing it at the appropriate times are differences that greatly impact the outcome. There are methods to make a decision to play or not play at a particular table in blackjack but not nearly as good as knowing the percentage up front as in trading. Both are games of skill and both can have an element of luck, although I believe luck is the result of good preparation.

Although the distinctions are subtle the outcomes can be dramatic between the two. There is no substitute for good money management and the patience to wait for the right trade to come along.

This blog excerpted from the book 'Essentials of Trading: It's Not WHAT You Think - It's HOW You Think, by Larry Pesavento and Leslie Jouflas. Available at www.traderspress.com

Leslie