You Don't Need To Predict The Future To Make Money In The Market
One of the most often asked questions by new investors is how can they determine which stocks will go up? The question is more complicated than that.
The truth is that a successful trader has an investment strategy that is not predicated upon predicting the future, which is impossible, but on taking positive expected value trades - meaning strong risk to reward positions.
What is the expected value of an investment strategy? The expected value is essentially the weighted average over a series of events. If your investment strategy involves having losing positions that are larger than winning positions, this means that to be successful over the long term you need to have a very high percentage of winning positions - this is extremely hard to do.
One fact that most professionals will not tell the retail public is that one can have a very successful investment strategy over the long term with even just a 50% winning rate.
Yes that's correct, half of your trades can be losers and you can still be profitable.
How is this possible? By having winning trades return a much larger percent than losing trades.
What if each time you got heads you would earn $1.50, but if tails came up it wide only cost you one dollar. Would you make this bet?
The obvious answer is yes, all day long. Knowing that 50% of the time you will earn $1.50, while the other half of the time you will only lose $1, the long-term expected value is massively positive.
Question: do you need to predict if it's heads or tails to be successful in this bet? The answer is no, because you are taking on a positive expected value proposition, with a high reward to risk position.
Similarly in the market, if one could develop an investment strategy where a winning position returned a larger amount than a losing position, the investor does not need to have an exceedingly large winning percentage to become profitable.
This provides a cushion, because at some point many of your investments will be profitable and the overall investment strategy will have high returns. But this will also protect against periods of low to normal winning percentage by providing relatively lower levels of risk and long-term stability.
No one can predict the future, yet many try. Look for trades that offer a larger reward to potential risk and this will help with the long-term profitability of an investment strategy.
Do you need help with your investment strategy? We offer one-on-one coaching developed by Professional Hedge Fund Traders and the team at BehindWallStreet.com can teach you how to trade like a Wall Street Professional.
The following article is from one of our external contributors. It does not represent the opinion of Benzinga and has not been edited.