Updated from its original posting on 2012-09-07
Ever stop to think how casinos actually work and make money?
Casinos rake in a ton of dough every single day, despite the fact that casino operators cannot predict with certainty which person will be a total noob and split 5s against a dealer showing a 10, or who will hit the jackpot playing slot machines.
How is this possible? Shouldn’t non-random outcomes lead to consistent profits? And if that’s the case, shouldn’t random outcomes lead to inconsistent profits?
Casinos are able to consistently generate profits because they understand that for each game, the casino has an EDGE over the players. They understand that over time, probable outcomes can actually produce consistent and predictable results, given that the sample size is large enough.
Just like a casino, traders are in the business of trying to be consistent and making money in a seemingly random work environment. The key is to think in terms of probabilities.
This is actually much easier said than done, because it requires two layers of belief that you would initially think cannot coexist.
1. Trade-specific Level
At this stage, you have to understand and accept the uncertainty and unpredictability of each trade.
Let’s go back to our casino example and use everyone’s favorite game, blackjack. While playing blackjack, you never know what cards you’ll be dealt, nor do you know how each player will play his or her own hand. These factors have a direct effect on the outcome of your hand.
And yet, there are some who make money playing blackjack because they understand that each hand is STATISTICALLY INDEPENDENT of every other hand and that over time, if they follow basic strategy, they can decrease the house edge and actually generate a small profit.
The same is true for trading. We have to understand that each trade is independent of every other trade. Whether you won or lost the previous 10 trades has no bearing on the outcome of your next trade. Once you accept this, you can easily take trades without being adversely affected.
2. Macro Level
You have to understand that over time and with a large enough sample size, the probability of profit or loss is relatively certain and predictable. This degree of certainty is based on the constant variables that are known in advance and most importantly, within YOUR CONTROL.
Once you recognize the independence of each trade and believe in letting good odds play themselves out, then you’ll have an easier time at removing emotions from your trades.
For example, you’re less likely to exit a trade early if you know that your trade idea has a good probability of winning in the first place. Similarly, you’re less likely to fuss over the outcome of each trade if you know that given enough sample size, your trading method will most likely work out in your favor.
But before you place too much confidence in your trading method, you must first make sure that it has an EDGE over the markets. We here at BabyPips.com have been ranting about having an edge because IT’S THAT IMPORTANT. Without an edge, you are just like any random fool who walks into a casino – yeah, you might win once in a while, but over time, the casino will win because they have the edge over you.
The key to having an edge isn’t found in paying bajillions of dollars for a “risk-free system” that can “guarantee profits.” In my hundreds of years of trading, I have found that the best traders find their edge by constantly looking for opportunities and tirelessly putting in the muscle work needed to fine tune their trading styles and methods.
The bottom line is that the consistently profitable traders don’t rely on luck – they rely on the knowledge that their system works because they have put in the necessary efforts to make it work.