Trade with the Numbers in Your Favor

Trading is a numbers game where the best can swing the odds in their favor, says Jeff White, discussing effective position sizing and how to overcome inevitable losing trades.

My guest today is Jeff White.  We are talking about trading as a numbers game, and how you can put those odds in your favor.  So Jeff, first of all, why is it a numbers game?  How do I work with that?

You know, the market-investing, trading-it really requires that you approach it as a numbers game.  Here is what I mean by that. If you take a look at Major League Baseball, for example. Lets consider a great hitter like Josh Hamilton.  The guy has like a .320 career average. At any single appearance at the plate though, we might see him do one of a number of different things. He might hit a homerun. He might walk, strikeout, or hit into a double play. We don't know in any one appearance, but over time his skill is going to produce the RBIs that he is capable of.  He is going to get on base a number of times over his next 500 at bats, and in trading you have got to look at it the same way. 

It is kind of like how a casino might lose money to one player, but they still have that house edge that is going to play out in their favor over time. So the casino's job is to get a larger sample size.  They don't get their feelings hurt, or get upset, if one player comes and beats them. It is just a matter of putting that edge to work over time. 

I think in your trading you have lots of advantages to doing that.  One is that you are sizing your positions in such a way that suddenly this trade doesn't mean everything. It doesn't mean the difference between life or death, or survival or not as a trader.  I am sizing this position in such a way that if it fails I can withstand that hit, and move on to the next trade. I have got to be able to do that. 

I love the baseball analogies, and with Josh Hamilton, that is a great one. If he goes 0-for-4, it doesn't mean he's not going to have a great day tomorrow or the next game. He will kind of shrug that off, and get back to his mechanics of hitting.  It is the same way with trading, right?

Absolutely, I think, and confidence is so critical in trading.  You have got to have some level of confidence to even step up and take that trade.  As traders, it is easy to get concerned with protecting our account values, but we also have this psychological capital that we have got to protect as well. By taking this numbers-game approach, you are being more patient with yourself.  If you endure a tough stretch, you are bouncing back with a little bit more confidence. That way over time, especially if you are winning larger than you are losing on any one winning trade versus one failed trade, as long as you have got that skew in your favor it doesn't even require great accuracy. It is just a matter of playing this numbers game, and letting your edge play out over time.

So, I think the question then becomes how do I know, if I have four losing trades in a row, if that is just statistically what is going to happen versus eight in a row, which still may happen, but I need to figure out if I'm not reading the market right, and if I need to make some changes?

That is a great question. I think that is totally fair.  I think as a trader, as you start to hit that rough stretch, the first thing you do is cut back on your size just in case you're not seeing the ball clearly.  So, you start cutting back a little bit, and then you just pay real close attention.  Am I missing something new that is taking place right now?  Do I need to be modifying my approach, or is this the type of thing that is just kind of a one-off occurrence, where maybe I just stepped out and took a hit, because those are going to happen in the market.

Over a period of time, if you are following those rules, you can hopefully make money.

Absolutely, and I think that is the aim.  I think in life most people, especially with their day jobs, if they are part-time traders they need to be right. I want a good doctor who is right all the time. I want a lawyer who is right all the time.  In trading though, you have got to accept being wrong. So, with this concept of it being a numbers game, you know at the start of the day, the week, or the month that I'm going to have some winning trades, and I'm going to have some losing trades. It is just going to boil down to how well I manage those losses that is going to ultimately make the difference for me.

Jeff, thanks for being here.