Trading: A Game of Probability
03/28/2014 9:02 am EST
Veteran trader Scott Andrews explains why he trades on high expectancy and high probability setups and shares why he got the nickname, "The Gap Guy."
ROB: We often hear that trading is a game of probabilities. I'm here with Scott Andrews, and you've said to me before, we want to trade on a probability basis, not on a possibility basis. Can you tell me what the difference is?
SCOTT: Sure. Well, a lot of traders starting out, they're reading charts, very discretionary, and every turn in the market looks like a possibility, possibly a good trade, right, so I used to be one of those traders and that's just not the truth. There are possibilities but you're just not going to make any money trading that way, so I really migrated over the years to evaluated set-ups, identifying when I have a set-up that I evaluate from multiple angles, multiple different views of the market, multiple time frames, multiple look-back periods. If they're in alignment, then I have a probability based notion for trading that trade, so like how the weatherman, they use ensemble forecasting, right, so I live on the East Coast, North Carolina, we have a lot of hurricanes and you can watch the swathe that they paint of where the most probable paths of a hurricane, so I'm doing essentially the same thing.
I'm trying to determine what's the most probable course for the market on a given day using multiple models, so that's a probability based view instead of putting a trade on that may be a 50/50 trade, which by the way I call those inflexion trades. You can make a lot of money on those, right, but for me personally I stay away from the 50/50 trades. Even though they can have a high expectancy, you're risking one to make three, 50/50 trade you make a lot of money over time. The problem with those trades for me is that I get into cycles where if you trade over, say, 100 trades at a 50/50, you're going to have eight, nine, or 10 losers in a row. It's not only possible, it's probable, and for me psychologically that starts messing with my head. I start deviating from my rules, tightening the stop a little bit, tightening the target, and all of the sudden I'm off path, so it doesn't work well for me. I like to try high expectancy set-ups and high probability set-ups.
ROB: Do you have a set-up that's your favorite?
SCOTT: Yeah, I've sort of got the corny nickname the gap guy a long time ago. I trade the opening gap. It's probably the only set-up, it's the only set-up I know that has a mean reverting bias during the course of a day that you can count on. It's a high frequency trade so it occurs every single day, almost every single day you have a good setup, and it has a 70% chance of reverting back from the open to the close of the prior day, and that's just about any equity market, so the indices and all the individual stocks, so you have the wind at your back, per se.
ROB: Well, we'd all like the wind at our back in the markets these days. Thanks, Scott.
SCOTT: Thank you.
ROB: You're watching the Money Show video network.