 Welcome back to the Trade Hacker Mindset. We are going to be continuing with our discussion topics from the Mark Douglas book, Trading in the Zone. And in this episode, we are going to talk about the trader's edge, thinking and probabilities. Trading the markets can be difficult to master and seemingly just out of reach. Professional traders have a secret. Trading requires total mental and emotional control. It requires the Trade Hacker Mindset. OK, let's jump into our discussion of thinking in probabilities. In the last episode, we talked about the market's most fundamental characteristic, which is that anything can happen at any time. And so if anything can happen at any time in the market to be able to be successful, we have to be able to think and trade in probabilities. At Navigation Trading, we always talk with our community about how we trade in statistics and probabilities, not hype or emotion. In other words, we're not trading on gut feel because we think a stock is going to go up. We're not trading on gut feel because we heard on CNBC or we heard some gurus say that something is going to happen in the market. Trading is a game of numbers. And if you can internalize that into your trading mindset, into your trading methodology, it's going to help you become a successful trader much quicker than you might think was possible. So let's dive in. So what exactly does it mean to think in probabilities? And why is this so essential to you becoming a successful trader? Because as we've talked about in previous episodes, we know that each individual trade has a very uncertain probabilistic outcome, meaning there is a chance that every trade you enter could be a loser. So if that's the case, how can you produce consistent results with something that's so uncertain? So to help provide some context, we're actually going to look at the gambling industry to help provide some answers to these questions. Think about this. If you've ever been to Las Vegas, you know exactly what I'm talking about. How do you think that they justify spending all this money on the bright lights, on the huge massive hotels and casinos when their primary function is to generate revenue from an event that has a purely random outcome? As professional traders, we want to think like the casino, not the average gambler. Many uneducated people compare trading to gambling. But the reality is, there are a lot of traders who gamble in the market, but professional traders are not gamblers. Let me say that again. There are a lot of traders who gamble in the market, but professional, the best traders are not gamblers at all. So here's an interesting paradox. Casinos make consistent profits day after day, week after week, month after month, year after year, in an environment that has a purely random outcome. So how could this be? And at the same time, most traders believe that the outcome of the markets is not random, that it is somewhat predictable. Now, whether you believe that the markets are random or predictable, wouldn't you agree that, shouldn't a consistent non-random outcome produce consistent results and a random outcome produce random inconsistent results? Well, the answer is that think about from a casino owner's perspective. What a casino owner and the best traders understand that the gambler or the typical trader finds difficult to grasp is that even if something has a probable outcome, it can also produce consistent results. If you can get the odds in your favor and there's a large enough sample size, there's a large enough number of hands in a game or a large enough number of trades, if the odds are in your favor, then you can produce a consistent result. The best traders in the world treat trading like a numbers game similar to the same way that casinos approach gambling. As an example, let's look at the game of Blackjack. So in Blackjack, the casinos have approximately a 4.5% edge over the player. This means that over a large enough sample size, a large enough number of hands played, the casino will generate a net profit of 4.5 cents for every dollar wagered on the game. And this takes into account all the players who walked away as big winners, all the winning streaks, it includes all the players that walked away big losers and everybody else in between. And at the end of each day, at the end of each week, at the end of each month or year, the casino always ends up with approximately 4.5% of the total amount wagered. So that 4.5% might not sound like a lot, but think of all the people that pour into Vegas or pour into these casinos, and suppose $100 million is wagered collectively at the Blackjack tables over the course of a period of time. Well, $100 million wagered, 4.5% of that is 4.5 million dollars. So what casino owners and professional traders understand about the nature of probabilities is that each individual hand played is statistically independent of each other. This means that each individual hand is unique, where the outcome is completely random relative to the last hand or the next hand. And so if you focus on each hand individually, there will be a random, unpredictable distribution between winning and losing hands, but on a collective basis, just the opposite is true. If a large number of hands is played, patterns will emerge that produce consistent, predictable, and statistically reliable outcomes. And that's what makes thinking and probabilities so difficult. It really requires two different layers of beliefs that on the surface seem to kind of contradict each other. So in the book, Trading in the Zone, Mark Douglas talks about the first layer, he calls it kind of the micro level. And at this level, you have to believe that the uncertainty and unpredictability of each hand is unique and uncertain. And you know that these are uncertain because there's always a number of unknown variables affecting the consistency of the deck that each new hand is drawn from. Think about this, for example, you can't know in advance how any of the other participants are going to play their hands. For example, if you're sitting at a table and there's five other players, you don't know if they're gonna take a hit, you don't know if they're gonna stay on a hand, you don't know if they're going to act a certain way based on which cards that they have dealt. So we know that each hand is random and statistically independent of another. However, the second layer is this macro level, this big picture level, where you know that if you have a series of hands, if you have enough statistical evidence, if you have enough number of occurrences from a very predictable, reliable way, you'll know the outcome of what happens. So there are constant variables, and these are basically in Blackjack, for example, these are the rules of the game. So even though you don't know or you can't know in advance the sequence of wins or losses, you can be relatively certain that if enough hands are played that whoever has the edge will come out in the end with more wins than losses. And the degree of certainty is a function of how good that edge is. So thinking in probabilities from a casino owner's perspective, it's the ability to believe in the unpredictability of the game at the micro level and simultaneously believe in the predictability of the game at the macro level with a large number of occurrences. So because casinos don't have to know what's going to happen next, they don't have to know what's gonna happen from on a hand-to-hand basis, they don't have to have any significance or emotional attachment to each individual hand. So they don't have this unrealistic expectation about what's going to happen, nor are there egos involved in a way that makes them have to be right. And as a result of that, as the casino thinks in probabilities, it's easier to stay focused on keeping the odds in their favor and just continuing to execute flawlessly, which in turn makes them less susceptible to making costly mistakes. The casinos stay relaxed, they're committed and they're willing to let the probability, which is their edge, play themselves out. And they know that their edge is good enough and that if the sample size is large enough, they will become a net winner in the end. The best traders in the world have the same mindset. They have the same thinking strategy as the casino. And not only does it work to their benefit, but the underlying dynamics supporting the need for such a strategy exactly the same in trading as they are in gambling from the casino's perspective. In gambling, the known variables are the rules of the game. In trading, the known variables are our strategy or your market analysis. Your market analysis finds behavior patterns in the collective actions of everyone participating in the market. We know that individuals will act the same way under similar circumstances over and over again. And this produces observable patterns and behaviors. And forget about trading, if you're just interacting with groups of individuals, you're gonna notice that they produce different behavioral patterns. Well, remember the market is just made up of participants. They're just made up of groups of individuals and humans act and they have patterns that reoccur over and over and over based on fear and greed and the decisions they're making based on how they're trading. The known variables in trading can also be the analytical tools that you're using. Whatever it is that creates your edge in the way that you trade. This could be a price pattern that happens over and over. This could be the implied volatility level that you use to create a certain option strategy. This could be the way that price reacts to a spike in volume. It could be a number of these different things. Next, we know that in gambling, a number of unknown variables act on the outcome of each individual game, right? So in Blackjack, going back to our Blackjack example, the unknowns are, how is the deck shuffled? How are the different players choosing to play their hands? If you've ever played the dice game, craps is how are the dice rolled? People roll them differently off their hand, right? If you've ever played roulette, it's the amount of force that someone applies to spin the wheel. All of these unknown variables act as forces on the outcome of each individual event that causes each event to be statistically independent of any other individual event. And that's why it creates a random distribution between wins and losses. So if you compare that to trading, how does that compare from a number of unknown variables? Well, for one, a trader might have a perception of different behavior patterns, or they see different patterns develop in the markets. Some other unknown variables are all the other traders who have the potential to come in the market, or the traders who already currently have positions and get ready to take off their trade. So each trade contributes to the market's position at any given moment, which in turn means that each trader, acting on belief about what is high and what is low, contributes to the collective behavior pattern that is displayed at that moment in the market. So if you see a recognizable pattern, and if the variables used to define that pattern conform to your definition of an edge, then you can say that the market is offering you an opportunity to buy low or sell high based on your definition. So if you take the opportunity to take advantage of your edge and you put on a trade, what factor will determine whether the market unfolds in the direction of your edge or against it? The answer is, it's the behavior of other traders. Think about that. At the moment you put on a trade, and for as long as you choose to stay in that trade, other traders will be participating in that market. They will be acting on their beliefs about what they think is high and what is low. So at any given moment, some percentage of other traders will contribute to an outcome favorable to your trading edge, and the participation of some percentage of traders will negate this edge. So there's no way to know in advance how everyone else is going to behave and how their behavior will affect this trade so the outcome of the trade is uncertain. The fact is the outcome of every trade that anyone decides to make affected in some way by the behavior of other traders participating in that market at the same time that you're in the trade. And since all trades have an uncertain outcome, then each trade has to be statistically independent of the next trade, and that has to be statistically independent of the previous trade. Even though you as the trader may use the same set of known variables to identify your edge in each trade. So if the outcome of each individual trade is statistically independent of every other trade, there must be a random distribution between wins and losses in any given string or set of trades, even though the odds of success for each individual trade may be in your favor. Remember, the casino owners, they don't try to predict or know in advance the outcome of each individual event or each individual hand. Casino owners have learned that all they have to do is keep the odds in their favor and have a large enough sample size, a large enough number of hands, a large enough number of occurrences so that their edges have the ample opportunity to play out over time. So think about this in your own trading. The biggest factor that I've seen affect whether a trader becomes successful or not, and this goes right in line with thinking and probabilities, is your position size. And if you've noticed in a casino when you sit down at a blackjack table, there's a minimum and a maximum that you can bet. Why do you think there's a maximum? You know, a casino wants you to bet as much as possible, right? Well, they want you to bet as much as possible, but they would rather have you do it over a large number of occurrences rather than one big lump sum bet. And the reason is, is because each individual hand is unpredictable, but a large number of occurrences is predictable. If you're a trader and you trade with too large of a size based on your account size, based on your risk tolerance, and you happen to hit a trade that's a negative trade and you lose money on that trade, if you've traded too large, that could put you out of the game. But if you keep your position size in check, if you keep your position size small enough so that you have the ability to let the probabilities play out and you can use that pattern, that whatever it is that you use to trade, that strategy that you have an edge in, and you can do that over and over and over again with small position size, you're gonna have the ability to let those probabilities play out. Whereas if you traded too big and it happened to be the time that you hit a bad trade, you could be out of the game. So keep your position size small, think in probabilities, and we look forward to seeing you become a successful trader. I hope you enjoyed this episode. If you want to be part of our trade hacker community, it's free to join. Just go to community.navigationtrading.com. We've got hundreds of traders interacting on a daily basis, not only about the mindset stuff, but sharing trade ideas and helping each other become more successful. Just go to community.navigationtrading.com. I'll see you in there or I'll see you in the next episode. Take care.