Tuesday, October 16, 2007

Trading against the odds

I think it must be human nature to love the underdog. It seems that it is often human nature to want to invest in the underdog. By that I mean play the low percentage bet or buck the odds. Now if you are in a casino you will get rewarded if the long shot hits with a sizable return on your original bet (not sizable enough for you to make money over the long haul though. Hey they don't build those casinos by letting gamblers win.) Let's take roulette for instance. If you put $5 on 13 and it hits you will be paid 35:1 or $175. Unfortunately there are 38 spots on the wheel so over the long haul you will slowly lose money. Now lets take a look at what's involved when you choose to fight the odds investing. I showed subscribers today that the odds were roughly 4:1 that the rest of the week should be positive. Now if you were in the casino you could expect to get paid at least 3:1 if the long shot hit. That's not the case here. If you do beat the odds and the market goes down there's no guarantee it's going to drop 3 times as much as it would go up. Actually the odds in this situation are skewed the other way. Historically the return has been 3 times higher than the drawdown on options expiration week by going long Wed. thru Fri. Either way the market is rarely going to reward you for playing the long shot. The market is only interested in taking away your money as fast and as unfairly as possible. Fortunately you have the option to be the casino and keep the odds in your favor at all times. Unfortunately because we love the underdog or because the market makes the underdog look so appealing it's quite often hard to make ourselves take the correct trade.