Not long ago, I was spending time with a friend of mine who I have been close with since we were children. For years, anytime my career comes up in conversation, he insists that trading is nothing more than gambling. I actually get this question from others at trading events as well. It is a very hard question for me to answer because I think the whole question is wrong.
Whether you are a trader, gambler in a casino, Pepsi buying advertising space on a network, retail store owner, casino, car dealer, franchise owner, street vender, someone who buys and sells things on eBay, and so on, YOU ARE A SPECULATOR at some level. The trader takes on risk in a market for a potential reward. The gambler risks a $5.00 chip on the black jack table to try and make $10.00. Pepsi pays $1,000,000 (risk) for a commercial spot during the Super Bowl hoping to see a return (reward) on that investment much greater than the cost (risk) of the commercial. The retail store owner buys inventory (risk) in hopes of selling that inventory to you and I at a much higher price (reward). I think you get the point. If you think of it this way, the real question becomes: “What type of speculator are you?”
Are you the type who only takes on risk when the odds are stacked in your favor, or are you the type that takes on risk when the opportunity “feels” right and “looks” good? My answer to my friend was simple. I said, yes, trading and gambling are very similar, but there is one big difference I told him. I said, “Imagine playing blackjack (21) and not having to put any money on the table until after you see the dealer’s cards, and then being able to bet as much or little or even not bet at all. Furthermore, if you do place a bet, you can take all your money off the table whenever you want; THAT’S TRADING.” In trading, we have the ability to only put our hard-earned money at risk when the odds are very much stacked in our favor. A casino would love to have the odds that the astute market speculator in the trading world is able to enjoy.
The issue is that most market speculators can’t tell the difference between risk and opportunity. In fact, most get it completely backwards which is great for the astute market player. This novice group continuously falls for the illusion trap that disguises risk as opportunity. Why is this the case? In my opinion, it’s a combination of human emotion and just plain old laziness. People tend NOT to want to put in the hard work and reality-based thinking it takes to develop the market skills needed to get paid from the “un-skilled.” There are no short-cuts. If someone is not interested in putting in the hard work it takes to attain proper trading skills, profitable trading opportunities will equally not be interested in them. The most rewarding opportunities always go to those who enjoy working hard and who engage in out-of-the box thinking, not those who lack interest in hard work.
I have written on many occasions, that the movement of price in any and all markets is simply a function of a pure supply and demand equation that is easily quantifiable on price charts if you know what you’re looking for. Low risk, high reward, and high probability opportunity is present when this simple and straight-forward equation is “out-of-balance.”
If you are a trader who risks your trading account on the inconsistent whims of random chance, you are likely the trader trying to cut corners and find short-cuts to trading success. In “compensation” the world over, everyone gets EXACTLY what they deserve. Life has a masterful way of evening the score. Your pay-back is eventually equal to your physical and mental efforts. If you’re not motivated to develop the needed skill set, you will likely transfer your account over to someone’s account who is. I have been in this business for many years. Trust me, if there was a short-cut to trading success, I would have found it.
You see, whether you are a trader, a company like Pepsi, a retail store owner, or one of the others, all that really matters is the type of speculator you are. Those who invest the time and energy required to attain a rule-based strategy that locks them into low risk / high reward profits simply get paid from those who don’t. The reality is that this is how the world works so let’s begin to qualify the difference between some higher probability trading opportunities and lower ones, as knowing the difference is a key to success.
A market situation we are often faced with is a gap. We can use a simple checklist based on objective information to determine exactly what action to take (or not to take). The checklist helps us determine the probabilities, risk and reward. Here is how some of it can work:
Scenario 1- Gap up into an objective supply (resistance) level
In a downtrend, selling short on a gap higher into supply is likely the highest probability trading opportunity there is. This is because only your most novice trader would buy after a gap up in price, into a supply level, and in the context of a downtrend. Therefore, we want to be the seller to that buyer which means the odds are stacked in our favor. This type of gap is likely to get filled very quickly.
Scenario 2- Gap down into an objective demand (support) level
One might think a gap down into demand is a buying opportunity right on the open of trading each time we see it. However, when we consider this action in a downtrend, this trading idea becomes a bit lower probability. While this gap is likely to fill and almost always does, it typically takes a bit longer than gap scenario #1.
Scenario 3 – Gap up into an objective supply (resistance) level
This gap up into supply is a trading opportunity that we consider shorting as long as the risk is low and reward (target) is high. However, this is not one of our highest probability trading opportunities because we are shorting in the context of an uptrend. This gap will typically fill within the day or soon after, but the higher probability gap trade to take in the context of an uptrend is scenario #2.
Scenario 4 – Gap down into an objective demand (support) level
In an uptrend, buying on a gap down into demand is likely the highest probability trading opportunity there is. This is because only your most novice trader would sell after a gap down in price, into a demand level and in the context of an uptrend. Therefore, we want to be the buyer to that seller which means the odds are stacked in our favor. This type of gap is likely to get filled very quickly.
If you have not figured it out yet, the key factor in determining which gap scenario offers us the greatest odds is a direct function of identifying who is making the biggest mistake. Someone buying a gap up, into supply (resistance), and in the context of a downtrend is making a very big mistake which means they are buying when the odds are stacked against them.
Therefore, we want to take the high probability trade and be the seller to that novice buyer and bet on a downside move. To summarize, the two highest probability gap trades are selling short when there is a gap up into supply in a downtrend and to buy on a gap down into demand in an uptrend. Of course, there is a little more to it than that when it comes to the exact entry. With any of these scenarios, the risk must be low and the reward must be high and this is objectively determined off of the price chart alone.
Sam Seiden can be contacted by email at Sam Seiden