Trading Probabilities: A Game of Chance?
In this video, Stuart McPhee, with a simple example, shows why most traders get it wrong when trading. He presents two boxes. You cannot see inside the boxes. But he can tell you that the first box has three marbles in it. Three of them are green and one is red. The other box has only one marble, a green one. If you would have the opportunity to put your hand in one of those boxes and collect only one marble. If you collect the green marble from the first box, Stuart will give you one thousand dollars, but if you collect a red one you will not get anything. And if you choose the green marble from the second box he will give you only $750.
He asks the public about their options, who would like to put the hand in the first box and who would like to put the hand in the second box. Now Stuart McPhee changes the situation and says that if you choose the first box and pull the green marble, you would have to pay him $1000, but if you choose one red marble, you don’t have to pay anything. And if you choose the second box and pull the green marble, which is the only one in that box, you would pay him $750. So he asks the public what box they would choose.
In the first possibility, you have the chance to make money, and most of the audience said that they would choose the second box, for sure money. Stuart McPhee said that the right answer would be the first box. In the second example, you face the possibility of giving him money, and the audience would choose the first box. Again, Stuart says that you should choose the second box, and he will give some arguments to this situation. He has done this test all over the world, but the reactions are all over the same. What he believes is that in the first case was a probability of income, of making money. The situations can be described as risk and as certain. Most people select the second box, they go for the certain income.
Stuart McPhee thinks that the most important trading rule is to let your profits run. When you can see the possibility of a profit, you should take it. But the rule says to let your profits run. You have to choose every opportunity that lets your profit get higher. People usually sacrifice long-term goals for short-term pleasures. In the second situation, if you face the possibility to lose money, not many people go for the certainty. People prefer to let go and see what happens. When this happens, they opt for the risk. It is a very natural thing to do.
If you do probability, you have to choose between three green marbles and a red one, or to choose certainty and take the green marble. His argument to that is if you have time to think about it and really go through the numbers and work the probability. But instinctively they choose not to take the risk when they can take for sure the money. Often you base your decisions on emotional instincts, so this is why people want to make quick money without risks.
Stuart McPhee quotes from this video:
- People usually sacrifice long-term goals for short-term pleasures