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Core of Trading: Decision-Making in Uncertainty

The essence of trading is making decisions under uncertainty. This decision-making process is similar to playing poker: you need to bet without complete information. This is why many successful traders often have poker backgrounds or are well-versed in game theory, as these fields teach them how to think strategically, assess probabilities, and manage risks effectively.

By adopting probabilistic thinking, you can shift your focus from predicting a single outcome to managing multiple scenarios and risks that may arise. As Annie Duke said in (Thinking in Bets): "When you think in bets, you consider the future as a set of possibilities rather than a single, predetermined outcome."

Every trade is a probability bet

Every trade should be seen as a thoughtful probability bet rather than a certain outcome. To succeed in trading, you need to view issues from a probabilistic perspective. Instead of focusing on the outcome of a single trade, consider it as one of many possible results. This mindset can help you avoid emotional reactions due to short-term losses or gains, as you understand that the advantages of a trading strategy will manifest over a series of trades.

Nassim Taleb reminds us in (Fooled by Randomness): "We often think the world is more predictable than it actually is and that we understand more than we actually do."

Example
Suppose you discover a low-volume altcoin trading opportunity, with strong technical signals indicating a possible breakout, but you also recognize the risks of low liquidity. By viewing this trade as a probability bet, you can choose to conservatively set your position size to keep potential losses within an acceptable range.

Core of Probabilistic Thinking

Understanding probability theory is key to adopting probabilistic thinking. At its core, probabilistic thinking involves estimating the likelihood of various outcomes and recognizing that no single trade is completely predictable, but over time, trading patterns will gradually reveal themselves. As Peter L. Bernstein said in (Against the Gods: The Remarkable Story of Risk): "The essence of risk management is to maximize the area where we have some control over outcomes while minimizing the area where we have none."

Example
Suppose you trade a basket of currency pairs based on a strategy with a historical win rate of 55%. You know the outcome of each trade is uncertain, just like tossing a weighted coin. However, because your strategy has a statistical edge, your focus is not on any single trade but on executing a large number of trades and letting the law of large numbers work for you. Even with losses along the way, as long as you stick to the strategy, the 55% win rate will ultimately translate into long-term profits.

Embracing Bayesian Thinking: Adjusting Expectations at Any Moment

An important component of probabilistic thinking is Bayesian reasoning, which emphasizes continuously updating your beliefs as new information comes in. In trading, this means you need to dynamically adjust your expectations based on market conditions and new data. As Keynes said: "When the facts change, I change my mind. What do you do, sir?"

Example
Suppose you observe a breakout pattern in a major cryptocurrency and initially estimate the probability of an uptrend at 70%. However, then an unexpected macro news item emerges, and you quickly reassess, lowering the probability to 50% and deciding to take partial profit. This continuous adjustment process is a manifestation of Bayesian thinking, helping you remain flexible in a dynamic market.

Recognizing Fat Tail Risks and Asymmetries

In trading, you must recognize that not all risks are equal. Markets often exhibit 'fat tail distributions,' meaning extreme events occur more frequently than expected. Understanding this helps you prepare for anomalies that could significantly impact your portfolio. Nassim Taleb warns us in (The Black Swan): "The inability to predict outlier events means the inability to predict the course of history itself."

Example
The crypto market is filled with cases of fat tail risk, and the collapse of FTX is a classic example. Initial concerns about the company's balance sheet rapidly evolved into a full-blown liquidity crisis, erasing billions of dollars in market value almost overnight. This event highlighted the inherent fat tail risks in the crypto market, where credit and leverage can escalate a single point of failure into widespread contagion, leading to extreme price volatility.

Luck and Uncertainty: Acknowledging the Role of Randomness

Luck plays a significant role in trading. While skill is indispensable, acknowledging the impact of randomness is equally important. By recognizing the role of luck, you can avoid overconfidence and maintain discipline. As Daniel Kahneman mentioned in (Thinking, Fast and Slow): "We tend to overestimate our understanding of the world and underestimate the role of randomness in events."

Example
Suppose you invested in a DeFi token, and its value unexpectedly doubled due to regulatory announcements. In this case, you should not blindly increase your investment in similar high-risk assets but rather be aware of the role luck played in this outcome, remain cautious, and continue to focus on trades where you can better assess the probabilities.

Avoiding the Outcome Bias Trap: Focusing on the Process Rather Than the Result

Judging decisions solely based on outcomes can lead to the trap of 'outcome bias.' This cognitive bias may cause you to overlook the quality of the decision-making process. To avoid this, you need to focus on the logic and process of decision-making rather than the outcome of a single trade. As Annie Duke emphasized in (Thinking in Bets): "The quality of our lives is the sum of the quality of our decisions and luck."

Example
Suppose you profited through high-risk leveraged trading during a market rebound. This may lead you to mistakenly believe your trading skills are exceptional. However, through process-oriented reflection, you may realize that this outcome was more a function of luck than a successful strategy. This awareness can help you avoid repeating risky behavior due to fortunate results.

Integrating Probabilistic Thinking: Building Long-Term Advantages

By focusing on probabilities rather than certainties, you can make wiser decisions in trading, effectively manage risks, and maintain discipline, regardless of the outcome. As Peter L. Bernstein said: "The future is uncertain. Therefore, decisions cannot be made with perfect confidence. But they can be made with courage."

Adopting probabilistic thinking is not only key to trading success but also a rational choice in the face of uncertainty. By understanding risk, applying Bayesian reasoning, and avoiding outcome bias, you will be able to build a long-term advantage in a complex market environment.