Futures Trading, Probability And Scalping
When asked about futures trading, or day trading in general
, the average fellow on the street will generally answer with something along the lines of, dabbling in the market is like Las Vegas, you can get lucky or be unlucky I always get a chuckle out of this answer, as the fellow is obviously not trained in trading futures, or the stock market in general.
Do you believe the market is just a matter of luck?
Most day traders will tell you about their favorite set-up or the trade that always works, and their are countless anecdotes about trade set ups that have never lost money. Of course, I would point out from the onset here, that no trade always works. Even the best set-ups go south from time to time. To count on a trade working every time will find a trader deeply disenchanted with trading theory. There is a logical answer to this dilemma though, and most traders understand this concept. They learn that trades and certain set-ups, and exits, for that matter, are a function of probability, and probability can either be your friend or your worst enemy.
In the world of probability, the complete range of potential outcomes are possible, however, certain outcomes within this range have higher probabilities than others. This makes sense. For example, an individual walks down the sidewalk on a busy street every day at 8 a.m. may experience several outcomes during her/her walk.
1. A car may jump the curb and run her over.
2. She may trip and fall, injuring herself.
3. She may trip and fall, not injuring herself.
4. She may walk along the route of her trip without incident.
5. She may walk and have a heart attack.
The list for possible outcomes for a walk on a busy street are nearly endless, and I have only listed a few, for purpose of example. But there are multitude of possible outcomes that an individual may experience on a walk. Which is most probable? Without analyzing a large set of observations it is not possible to scientifically give you this answer. But logic tells us that on most days he/she walks down the sidewalk on a busy street without incident, as most people do. To be sure, the vast majority of times the individual takes this walk it is an uneventful task given little thought. However, does that mean that on the first day he/she makes this walk she will not fall and break her arm? No, because falling and breaking her arm is within the range of possible outcomes of her walk. See? I think you get the idea.
Trading is very similar to this example, but when trading it is important to understand that on a given trade there are a vast set of possible outcomes the accompany each trade. One outcome will have the highest probability, and then there will be a subset of less likely possibilities. In other words, in the world of probability (whether it is walking down the street or trading a futures contract) there are a wide range of possibilities.
Now lets throw another variable into the trading mix: Time. In probability, the shorter the time interval being examined the higher the accuracy of probability theory. Conversely, the longer the time period under examination the lower the accuracy of predicting an outcome.
Why?
As time passes, new variables enter any equation and the ability to account, in a probabilistic sense, the potential outcomes of the action in question becomes more difficult. Put more simply, more things can happen over a long period than a short period. But it is still important to realize that the full range of possibilities can occur over any period of time, but some probabilities are less likely in shorter time frames. That reason alone, was enough to justify my commitment to short term trading years ago. There were other factors, of course, but it stands to reason that trading in highest probability set is a very appealing approach to trading futures contracts.
Okay, okay, so I can hear you saying you get the basis premise of probability. So what does probability have to do with trading? Well, the same principle that applied to the individual walking down the sidewalk on a busy street applies to trading. Every trade has a set of potential outcomes and each outcome has a potential probability. Over the years, trading theorist have developed certain set-ups that have a higher probability of success than other set-ups. Further, we stated earlier that the short period of examination results in higher degrees of accuracy, from a probability standpoint.
I trade intraday, usually in three minute intervals. Of course, the first bar of any trade has a binary outcome, that is, it can either go up or down. We will exclude the null set in this example, which would be the price stays the same. The second bar in the trade also has the same set of outcomes, and so forth. Since I trade in very short time intervals, I feel my ability to apply the theory of probability and test the possible outcomes of certain oscillator/price action outcomes produces a higher rate of success than trying to predict potential outcomes over a longer time period. Hence, in the complicated formulas used to predict probability, I stand a higher chance of choosing the trade with the highest probability of success.
There are a myriad of books written on the probability of trading and set-ups and they make fascinating reading and I recommend further exploration of probability and intraday futures trading. The literature can bring many aspects of trading into sharper focus and dispel the notion that intraday trading is simply an expression of individuals who do not fully understand the underpinnings of trading.
by: David S Adams
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