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Options Trading Odds – Is the pursuit of perfection slowing you down?

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by Mike Rykse

There aren’t many activities that I love more than trading. Being a sports fan is something that ranks right up there though. It’s amazing how many similarities there are between the two. I was reminded of this while working with one of my Options Mastery students over the last few weeks. One of his biggest struggles was feeling the need to be perfect before committing any capital to work. Often time’s retail traders are working with smaller accounts which can lead to trading with scared money. They try and wait for the guaranteed winner before pulling the trigger, when in reality there is no such thing as a guaranteed winner. The most successful traders are the ones that can recognize a system that puts the odds in their favor on every trade and then take each trade as they come. So how does this relate to sports and options trading odds? Let’s take a look.

 

The summer months in the U.S. for sports fans are all about baseball. As a baseball fan I’m always amazed by how much players are paid, when in reality they fail more often than they are successful. Let’s take a look at batting average, which is one of the most tracked statistics for baseball players. The player with the highest batting average as I write this article is Troy Tulowitzki of the Colorado Rockies with an average of .350.

This means the best hitter in baseball this year is successful between 3 and 4 times out of 10. Tulowitzki makes $10 million a year to play to be right 30-40% of the time. Arguably one of the best hitters of all time is Miguel Cabrera who plays for the Detroit Tigers. Cabrera year in and year out has one of Major League Baseball’s highest batting averages. At the time of this article Cabrera is batting .315 for the season. This means he is getting a hit just over 3 times out of 10. Cabrera signed a $292 million contract last year to play for the Tigers.

The point of this whole example is to show how much money these players can make with only a 30-40% success rate. In fact out of the hundreds of MLB players there are only 20 or so players that have a batting average over .300. If teams waited for the player that could get a hit every time they came up to bat they would be stuck with an empty team. Perfection is not even a consideration but yet players are making millions of dollars each season.

 

Options Trade Averages

 

 

In trading, it’s important to understand that like baseball we can make a lot of money without being perfect. I trade certain stocks and ETF’s that only win 55-60% of the time but yet they produce massive profits over time. The traders that are waiting for the perfect setup or the perfect system are the ones that will be caught in the never ending cycle of using new products. The key in my trading is staying consistent. I know I have a system that puts the odds in my favor. I know unlike baseball players that only get a hit 3 times out of 10 I can be successful 60-70% of the time. However, the only way I can take advantage of those odds is to take every trade as they come. I can’t wait for the perfect setup. There is no such thing.

 

It’s also important to point out that even with a system that wins 60% of the time, I will have losing streaks. Let’s take a look at the chart below. A system that has a 60% win rate will have a 100% probability of experiencing a 5 trade losing streak at some point in time. I have a 10% probability of losing 9 trades in a row. Understanding these probabilities shows how important it is to keep your size small. I would rather take trades with a small percentage of my overall account rather than taking large trades which many retail traders do. Keeping my risk small let’s me stay in the game long enough to let the odds play out in my favor even through the losing streaks.

Options Drawdowns

While there are no guaranteed contracts in trading like there are in professional baseball it’s easy to see that we can make a lot of money without the need for perfection. In fact the pursuit of perfection can be detrimental to traders if you are not careful. Understanding that being right 100% of the time in trading is not possible is the first step towards becoming a successful trader. You need to commit to a system that puts the odds in your favor and as long as you are using small risk it doesn’t matter if a losing streak comes along.

I mentioned earlier that I trade products that only have 55% win rates but yet they are producing thousands of dollars each year. I keep the big picture in mind and know that in the end I will make money. This allows me to focus on executing my trades correctly instead of looking for the next great new system that hits the market. Trading is not a game of perfect but a game of managing risk. Understanding your odds and then letting those odds work in your favor is what separates the great traders from the average retail trader struggling to get by.

While most of us do not have superior athletic ability that allows us to make millions of dollars playing sports, we can make a great living through trading as long as we ditch the pursuit of perfection and focus on making sure the odds are in our favor.

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