Day Trading Math
Investing is about making bets on the future on what you believe will happen. This is fraught with danger because it is the future innit. Your job as an investor is to raise your chances of your prediction coming true much as possible. The approaches to doing this are: 1. Hoping that something that happened before will happen again. 2. Predicting that certain unique things that are happening in the present will come together to make your prediction come true. 3. Take a gamble and flip a coin no one can really predict the future anyways.
All these approaches have their advantages and you will use elements of each depending on the type of person you are.
Day trading is making these bets over short periods of time. Sometimes for seconds others for under a day. The internet is full of communities that promise fantastic returns over very short time periods but unfortunately, with these type of returns there is the risk that you will lose your capital as quickly.
If you look at a short term trade probabilistically, you can only make money if the stock moves in the direction you want. As stocks move three ways (up, down and sideways), you only have a 33% chance of correctly picking the direction. For a sideways movement, you may not lose a lot but there may be transaction fees, opportunity costs as well as a cost to your attention as there is a maximum number of shares you can simultaneously be looking at any given time. Even if the stock moves in the direction you are expecting, it should move enough in order to justify the trade.
Because this is worse than a coin flip and the odds are stacked against you from the beginning. To achieve some level of success, it is crucial to have a tested strategy in place from the very beginning.
A popular strategy is to try and ensure that your winning potential is at least double your losing potential. Figuring out the maximum you can lose on a bet is easy as you can set a stop loss for this amount. The amount you can potentially win is a lot harder to calculate. This can only come with experience and calculating this as a new trader is like generating a random number.
The math Success in this case would boil down to two variables. The number of successful bets and the realised profit from each. Increasing either of these variables will be the difference between a successful trader and you losing your capital one drop at a time.
Say you have a strategy that gives you a profit of $100 50% of the time but on the other 50% you reach your maximum stop loss of $100. Not taking transaction fees into consideration, this would just break you even.
If you get it right 60% of the time:
Or if you increase your potential winnings to $150:
Over the long term therefore, you could be consistently profitable if you do this as a system.
The more you refine your systems the more likely your successes and the more profits you can squeeze out of every trade. A statistical approach helps here. If you can find a pattern in price movement that happens more often than not, you can apply this concept to it and hope what happens in the future is a slight reflection of what happened in the past.
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