Sunday, June 12, 2016

The Surprise Side - from the Phantom of the Pits

Here's an excerpt from the PHANTOM OF THE PITS. I know that this is something that I should know about trading, but I never thought about it this way. It's (instinctive) common sense to look both ways before crossing the road, regardless of what the rules say.

The Surprise Side

POP: When the walk light comes on, assume there is traffic that will run the red light at each intersection you cross. What do you do now before you cross the intersection?

ALS: I would double-check and look both ways before crossing.

POP: Of course, that is the correct answer -- you know what I am after. Now, just because you looked both ways before you crossed and each time you cross you looked both ways and each time there wasn't any traffic that ran the stop light, is there any reason to stop looking each time you cross the intersection? Your answer, of course, is no, you won't stop looking.

What kind of limits did I just give you? Are they life-saving limits before you cross the intersection? Yes, they certainly might be, but you will never know that if you follow the restriction each time you cross the intersection. You can't know if it saved your life for you prevented finding out by looking each time.

But what if you don't look and you lost your life. You certainly won't know you should have looked either.

Does the restriction tell you that, if you look, there will never be any traffic running the stop light? No. Does your experience of crossing and looking tell you what the probability of someone running the light will be? You can make an assumption based on your knowledge at this point. What does an assumption do? It actually presents criteria based on proven facts that are a possibility. It in no way gives you a high probability or low probability but the best answer you can present.

I don't want to lose you in this thinking but to point out that it's the same in trading as in crossing an intersection. We need to make our best assumption of what is possible. We must plan for that assumption in trading as long as it is a possibility and not just when it is probable. This is a very important point in understanding Rule Number 1 correctly!

If you were never to look at the intersection until proven wrong for not looking, wouldn't it be too late? It is the same in trading. You must protect yourself from any possibility in trading and not just protect yourself when the probabilities are high.

This will be the surprise side in trading The surprise side is a possible outcome but not a very high or likely probability like today's grain trade. When someone gives you a gift, you are surprised by it. Getting that gift was not a high probability. However, you are prepared for that surprise because you say, "Thank You!"

Most traders plan only for the probability side and that, to them, is always what they consider the winning side. This is the biggest mistake you can make in trading. Instead, you must plan for the losing side.

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