Concept #2: Probabilities & Odds
Generally speaking, nothing is certain in investing or trading. So, it’s important to get comfortable thinking about probabilities and odds
If I gave you a stock trade idea with only a 20% probability of profiting, would that be a good or bad idea?
Or would it depend?
At first glance, the low probability of success may scare you. But the question is incomplete.
A 20% probability means that on average the trade would profit only 20x out of 100 tries, or 1 out of every 5. While that doesn’t seem like much, the answer to the question presented is “it depends.” It depends on how much you risk on the trade vs. how much you expect to profit when it does win.
Probabilities are interchangeable with “odds.” Let’s take a look.
Using this example, let’s say there are 100 total outcomes and 20 expected positive outcomes. The probability is calculated by taking the total positive outcomes and dividing by the total possible outcomes. In this case 20 / 100 or 20%.
To calculate the odds, you would take the negative outcomes and divide by the positive outcomes. In this example, 80 / 20, or 4 / 1, which you can say “4 to 1.” 4 negatives for every 1 positive outcome.
Let’s practice a few.
Do this a few times on your own It simply takes a little practice.
Probability and odds are important and are often used to analyze the risk of a trade.
The Question and Answer sheet will go through many examples to ensure you feel comfortable.