Monday, February 21, 2011

High Probability Trading

I was introduced to the Monty Hall Problem in the series Numb3rs Season 1 "Manhunt". You can google "Monty Hall Problem" and you should get a lot of hits about this problem. Basically the problem is like this. There are 3 cards and 1 shows a ferrari while the other two show a goat picture. The objective of the game is find the car. The instructions of the game are as follows :-
  1. Out of the 3 cards, place your single choice
  2. Once placed, out of the two cards, the host will open one of the card that contains the goat
  3. The host will ask if you will like to switch
  4. This is the last chance to switch and once you decided whether to stay or switch, your choice card will be opened.
A simulation of the Monty Card Problem can be found here.

From the understanding of this problem, one can see that by understanding probability, one can increased the odds of winning.

Let's say that we have 3 traders, 2 who follows a system and 1 who do not have any system.
One of the traders who follow system switches his choice while the other stick to his choice. The one who does not follow the system sometimes stick and sometime stay. If I will to simulate the result of all 3, the one who switches will has the best gain. This is what I call High Probability trading. If one is able to have a system of indicators where each indicators give the probability of winning, average them up and if the sum met a certain threshold for entry, I believed such system will give a really good edge for that trader. Of course, at the same time, one may need to create indicators to determine exit as well.

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