Making profits doesn’t mean you made the right trade. Making losses doesn’t mean you made the wrong trade.
Let’s illustrate with a dice game.
If you roll 1, 2, 3, 4 or 5, you win $50. If you roll a 6, you lose $10.
You chose to play this game. You rolled a 6 and lost $10.
Does that mean you made a wrong choice? Of course not, that dice game is greatly skewed in your favour. You should that take bet.
Similarly, short term trading profits and losses do not determine if the trade was right or wrong.
First Principles - Keep Asking Why
To decide if a trade is right or wrong, you need to think from first principles. This means to question your decision until you reach the base rationale/assumption.
For example, I want to short bitcoin because China is banning cryptos.
- Why? Because crypto will fall due to lesser demand.
- Why? Because it hasn’t fallen yet and the news is not priced in.
- Why? Because the news of the China crypto ban hasn’t reach outside of Asia, and this piece of news is unexpected.
- Why? Because I read the news on Weibo (China’s version on Twitter) by reputable posters just seconds ago. (This will be the first principle)
From here we need to calculate the expected value of the trade (taking in consideration the probability that the Weibo posters are wrong) and plug these figures to an appropriate formula to get the correct bet size, but this is a story for another day.
P.s. Another way to see if a trader consistently makes right trades is to evaluate his performance over decades.
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