Trading can be thought of as a game played for money. The rules of
the game are relatively simple. The object of the game is to increase the funds in a trading account by buying and selling
with other players. Each player can choose from any of the following actions:
- Open Account
- Close Account
- Add Funds to Account
- Withdraw Funds from Account
Buy and Sell can only be done when the markets are open. A player may Buy then Sell (long
trade), or Sell then Buy (short trade). Profits are realized by selling for more than the buying price. The
prices for each sale are determined by market supply and demand and are not under control of the players. For each Buy
there must be a player on the other side of the trade who is Selling. There is no limit to the number of turns a player
may take while the markets are open.
If a player loses all the money in their accounts they are out of the game.
How to Win The Game
In order to win the game (i.e. continually increase the amount of money
in your trading accounts), it is useful to use the analogy of a casino.
A successful casino makes money by facilitating the playing of games in which the players have
a slight but real statistical disadvantage against them every time they play. For example, Black and Red in roulette
payout at odds of 50/50. But the 0 and 00 on each roulette table are neither black nor red, so the chances of black
or red winning are both less than 50/50. This slight edge, applied over many thousands of spins of the wheel is what
guarantees that the casino makes money and that the players (overall) do not.
Unsuccessful (i.e. losing) traders, are similar to the players in a casino. They repeatedly
play a game where the odds of winning each trade are less than 50/50 due to the bid/ask spread, commissions, and taxes.
In order to win at the trading game, we must operate like a casino, not like the players
that play the casino games. This means we must create a trading method or system where the odds are tipped in favor
of the player, not the market.
For the odds to be advantageous to the trader, the following equation must be true:
(Probability of Win * Average Size of Win) - (Probability of Loss * Average Size of Loss) >
This, coupled with the number of trades per year, determines whether a system will make money
overall or not. Unlike a casino, which will eject a profitable gambler, there are no rules that can kick you out of
the trading game for making too much money (as long as you do not trade on inside information).