Trading vs gambling

trading vs gambling

Ok, this is one of my favorite articles so put your seat belt and follow me 🙂 Why is trading very different from gambling? In order to answer that we must see what gambling is all about. But even before that, let’s talk for a bit about statistic events. Statistical evens can be either dependent or independent.

Independent events
If you throw a coin  there are 50/50 chances to come out your desired result: head or tail. No matter what you do, even if on previous 10 throws the tail came out 10 out of 10, the probability of success will still be 50%. The current throw is not at all dependent of the previous one. It’s a very popular saying among professional gamblers: “luck has no memory”. Suppose you pray God to send you a taxi and right after the corner you see the yellow color of a cab. It’s simply a coincidence, there is no correlation between your prayer and the cab. Your brain makes those connections and cheats you all the time. That’s why 95% of traders lose their money.

Dependent events
Did you ever heard of russian roulette? The gun has 6 chambers and only one chamber is loaded. What are the chances to get killed if you pull the trigger? 1/6=16,6%. If you spin the cylinder and pull the trigger again you still have 16,6% chances to get killed because there is no way to know where the bullet is. This is the case of an independent event, because the cylinder was spun, the current event is not dependent of the previous one. But what happens if you don’t spin the cylinder and pull the trigger again right after the first shot? Then, the current state depends on the previous state because we already know that the current cylinder comes right after the previous one! Here is the chance table to get short if you don’t spin the cylinder after each shot:
first shot – 1/6=16,6%
second shot – 1/5=30%
third shot – 1/4=25%
fourth shot – 1/3=33,3%
fifth shot – 1/2=50%
final shot – 1/1=100% <– say hi to Jesus

This is what a dependent event is.

If everything is clear now and it should be, let’s talk about a very popular game called roulette. The roulette is composed of 37 numbered slots. The first number is 0 and the slot is colored in green. Then, the rest of the slots are alternately colored in red and black. There are different ways to play, but let’s keep things simple: you can place your bet on either black or red but when the ball hits the 0 slot you lose, the green color belongs to the house. Because the roulette is spun right before every bet we are dealing with statistically independent events here. So, we have one green slot, 18 red slots and 18 black slots. If you place your bet on either red or black your chances of success are 18/(36+1)=18/37=48%  P =favorable outcomes/total possible outcomes.
You you place your bet on black, favorable outcomes = 18 because there are 18 black slots. Total possible chances are 18 blacks + 18 reds + 1 green.
So, the conclusion is you have only 48% chances to win not 50% as you may thought at first glance! You will never win at roulette on the long run because the green always goes to the house. The house always wins! According to the law of large numbers if you spin the roulette 10,000 times $1/each spin you will end up losing 100-48=52% of your money which means $5200.

But how about another popular game called Texas Holdem? Or Blackjack? I won’t go into details but what matters is, at some point, some players are folding their cards or some cards are shown face up. At this point a smart player can begin the calculations: given the fact that he knows what cards are on the table and in his hands he can make an educated guess about his chances of winning the game, and quit or raises the pot accordingly. We are dealing with dependent events here.

The conclusion is not to play a game based on independent events! You will always end up losing!

Why am I trading forex in the first place? Because we are dealing with dependent events. Even if the spread goes to the broker I still have good chances to win. Forex is not gambling. Forex market is moved by real economic news and crowd psychology. Forex is not betting. In forex I can move my stop loss and take profit. In gambling I can’t change a bet right in the middle of it. If forex there are situations in which you can earn easy money with almost no effort and here is an example.

As I’m writing, the EURUSD is in range because there are no fundamentals. The best thing to do when the market is ranging is to buy at the bottom and sell at the top because there is no trend to follow! Please see the attached image:

EURUSD

EURUSD

I have just sold at the top. If the EURUSD will head to the bottom as expected I’ll get my profits. If it closes 20 pips above the top I’ll close my existing position and open a buy right at the beginning of the trend. Breaking a boundary means nothing, closing above it means something. Most of the time, statistically speaking when that happens a new trend is formed. all I have to do is to set my stop to 20 pips and a much larger TP. Today at 5pm a high impact news is expected so I will monitor everything very close.

Forex is not gambling!

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