Professional option traders are statistically passive(That is, I don’t care how likely I am to win this time. I want to win, on average. This means that they want to win on average. A good option trader will frequently make a trade even though he thinks it will probably lose money. Frequency of winning is not the main focus, but payoff (odds) are. The inane slogan "You're only as good as your last trade" is dangerous. We can’t know what is going to happen all the time. We must remain statistically passive. You’re not right about a position nor are you wrong about a position regardless if the trade works out for you. Again, remain statistically passive. If I am in the business of trading options to make a profit, it is the statistical expectation that matters the most. On the other hand, bad option traders focus largely on frequency. They like the probability of the trade to heavily be in their favor, thus taking on remote hidden risks. If the PoP is 99.1%, the remaining 0.09% contains a ticking time bomb that will eventually explode, on average. Bad option traders have a string of "good" trades that bring profits and then get hit with the big kahuna. They blame it on something else and resume their old ways, not knowing that it will continue to happen again and again until they hit the "absorbing barrier" aka ruin. They're too anxious to win.
Example from "The Business of Options" by Martin P. O'Connell, pg. 5 Suppose I would like to bet that I can roll a 4 in a single roll of one die. Of course, if you insist on even odds, I'm not going to bet because I know I only have one chance in six of winning. On the other hand, if I can get 10-to-1 odds, I am going to make that bet. I am going to make it fully expecting to lose, and I am still going to think about it as a business. Notice that the word "expect" might be used here with two different meanings. I expect to lose (meaning I'll probably lose) but I have a positive expected return in the statistical sense. --- This is what matters the most. The statistical expectation. You don't care if you win this time, but that you win on average. --- (continuing) Suppose I make the 10-to-1 bet and roll the die and get a 2 instead of a 4. Was I wrong? Of course not. I'm no dumber than before the roll, and also no dumber than if I had rolled a 4. If I had rolled a 4, the result might make me feel brilliant. That feeling would be simple emotional weakness. To be statistically passive is not just to make a trade without thinking I know the result. It also requires ignoring the temptation to think that the result indicates the quality of the trade.
Correct. As professional options trader Martin O'Connell(who advised the likes of Nassim Taleb) put it in "The Business of Options, pg. 5".. In the options business, simple statistical concerns are often well clarified through the use of gambling examples. Edit: And you said "trading", I am referring to options trading, options are multidimensional and nonlinear, and the use of gambling examples help illustrate certain concepts. Makes sense?
Books almost always make sense. Theory is great. Statistics are awesome. I agree with @Overnight, somehow trading is always way harder than that. The odds are not set in stone, so having conviction is difficult unless you KNOW what your edge is(and when it's gone). The question is, how much can you afford to loose and stay "statistically passive?" Oh wait, I know, for as long/much as your statistical back-testing tells you to. Unless you made some mistakes, or your data was bad, or execution is not as good, or market mechanics changed? What does O'Connell say about this?
Thank you for your comment. 1) As Nassim Taleb puts it "Probability is not a mere computation of odds on the dice or more complicated variants; it is the acceptance of the lack of certainty in our knowledge and the development of methods for dealing with our ignorance" 2) You must use heuristics to survive long-enough to have convex bets payoff. On one hand, you can have high PoP trades and win pennies risking dollars, on the other hand, you can bleed your account hunting for low probability, high payoff trades. This is where a skilled option trader uses heuristics to survive. One famous method is the Kelly(Half-Kelly) Criterion used by Ed Thorpe among other professionals. No, this isn't the answer, but it is part of the answer. The other can be a locally concave, globally convex setup. And there are few other methods. You will not know the odds on anything in a domain such as the stock-market given its power law dynamics. 3) The focus is on price. Conviction comes when you see an attractive price and price only, then take advantage using heuristics that take into consideration betting size, survivability, bleed, and payoff. 4) No statistical back-testing needed. You run into the problem of induction. Makes sense? P.S. Books don't always make sense (such as option books based off Gaussian assumptions)... and statistics is not great, in fact it has caused more harm than good in this world, especially in finance. And most theory is based off unrealistic assumptions (BSM). You can use heuristics used manyyyyyy years ago to price and trade options today and gain alpha. Next time take your f*ckboi sarcasm out of your response.
O'Connell and Piper probably did more than any other group to create the modern CBOE. Probably trained 30 - 40% of the floor "back in the day". If you can ever obtain a copy of their original VHS tapes on trading options - beg, borrow or steal to get them.
There is something off about this rally. I am not going to put money on this conviction tonight at least, because I cannot afford it. But something is starting to smell iffy. I dunno'.