Stocks Trading Lesson1 – An Anaolgy to Betting With a Coin Toss

This is my first post on stocks trading. It is one of my interests, and have spent a great deal of time reading books, and trying various techniques. I will regularly make posts with tips and techniques and trading strategies, and will compose all my posts into a few articles and publish them on my main website http;// There are many aspects to trading stocks, and I will add posts with standard knowledge and my experience and tips with it which include.

Aspects of trading

  • Trading Fundamentals i.e. how to place an order. Place a stop loss, limit order etc.
  • Fundamental Analysis i.e. how to evaluate a company e.g. earnings ratios
  • Technical Analysis i.e. how to read a stock graph and analyze it
  • Trading psychology i.e. how to maintain your head and not panic
  • Sources of knowledge i.e. magazines, books, seminars
  • Trading strategies and how to tune them to your style
  • Trading platform analyzing fee strutures
  • Rule Base trading and back testing strategies
  • Trading time frame, e.g. investing in 401K vs day trading vs week to month trading
  • Risk Management
  • Trading Plan

Is trading like gambling? Analogy to betting with coin tossing
Some of my friends think that trading stocks is like gambling. And to a great extent my friends are right. One never knows what the future beholds. If you flip a coin it could be heads or tails, you win or loose. So whats the point so many people go for stocks. Are all playing for the thrill of it? Why do they not all go to a casino instead.

Lets play a game to better understand what trading is. Lets say you have 100 dollars and I give you a special coin. Also i make the coin slightly skewed such that on average the heads come up 51% vs 49% tails i.e. i slightly skewed the coin in favor of heads. Also suppose you have a millionaire friend who is willing to bet with you as many times as you like. He does not know that the coin is skewed for the heads. And also you get to call heads or tails and the amount of the bet. Do you think you can play such that you can double your 100 dollars? Or even better become a millionaire i.e. win all your friends money?

The answer is yes. Do you know that casinos build their huge empires of wealth just with that much odds in their favor?

How does one play such a game. An obvious answer is always call heads (this is like trading the best stock e.g. AAPL or GOOG of these days). But there is another aspect to it. What should be the bet size. Should you bet all 100 dollars, so you can immediately double your money in the beginning? Should you bet half of it, so you only loose half worst case if the first bet is lost? How do you increase your changes of success. If you were to bet staight with all you money you are taking a risk of 100 percent. You could go clean on your very first bet, so that doesn’t seem to be good idea. If you were to make a 50 dollar bet, you could loose all your money in 2 bad bets, but it is still better than 100 dollar bet, because you at least have 2 chances. How about bet with a dollar. That makes a lot more sense. Because you know how unlikely it is that you will get 100 tails in a row. If you could, you should bet with the lowest possible risk lets say a penny, and bet a gazillion times with your friend. One day you will have all his money. I.e. bet with a coin which is slightly in your favor, and bet many times with small amounts (e.g. a penny). Out of every 100 win you will win 51 times and loose 49 times i.e. on average on every 100 bets your bank balance will increase by 1 penny and your friends balance will decrease by the same amount. Once you earn upto a 1000, you can increase your betting size from a penny to a dime. Now after a 100 bets your bank balance will increase by 10 cents. And then when you become more richer you can bet with a dollar and so on. The power of compounding will exponentially accelerate your path to richness.

The above game is simply what trading is all about. In real stock trading replace coin flip with stock going up or down. Going up means you got a head. Stock going down means you got a tail. Trading with a small amount means that you have placed a stop loss i.e. a fixed amount that you would loose on a trade, and invested a small percentage of your trading capital. The part that the coin is skewed, is a valid tested trading strategy. And yes you can develop a trading strategy that is “skewed” in your favor!