Betting strategies employed in gambling can have parallels to risk management in stock and commodities trading. While there are inherent differences between gambling and trading, certain principles and strategies can (and should) be adapted. I’m bringing this up here for one critical reason - gambling odds aren’t good… but pros still make money.Even at purely random 50-50 odds, someone with good betting strategies can make great money.
So while we want to acquire an edge that improves our odds of picking winners as much as possible, position sizing and risk management is indispensable. And I want to focus on gambling strategy here because it removes the noise of people thinking they can predict the future in the market, and rather assumes that good ‘lucky’ feeling may not be a great benchmark for position sizing.
Let’s look at how and why betting strategy relates to risk management in trading, along with examples of portfolio management that parallel these concepts:
Bankroll Management and Position Sizing:
- In gambling, bankroll management involves allocating a specific portion of one's total funds for each bet. This approach helps control risk and prevents excessive losses. Similarly, in trading, position sizing is crucial to manage risk. Traders allocate a specific portion of their portfolio to each trade based on factors such as risk tolerance, market conditions, and position correlations. By managing position sizes, traders can limit potential losses and diversify their portfolio.
Example: A gambler sets a rule to never bet more than 5% of their total bankroll on a single bet. Similarly, a trader may decide to never allocate more than 2% of their portfolio to a single trade. This way, both the gambler and trader limit their exposure to individual risks and protect their overall capital.
Risk-to-Reward Ratio:
- In gambling, understanding the risk-to-reward ratio is essential to make informed bets. A favorable risk-to-reward ratio means that the potential reward outweighs the risk taken. Similarly, in trading, assessing the risk-to-reward ratio helps traders determine whether a trade is worth pursuing. By targeting trades with a favorable risk-to-reward ratio - key inflection points in hot markets as discussed above - traders can aim for profits that exceed potential losses.
Example: A gambler places a bet with odds that offer a potential payout three times the amount they risk. In trading, a trader may enter a trade where the potential profit is three times the potential loss, providing a favorable risk-to-reward ratio in both scenarios. In the strategy I’ll present below, we’ll be aiming for an average payout of 7x the amount we risk, assuming that we’ll target 2 winners out of 10 trades.
Stop Loss Orders:
- In gambling, some experienced bettors use stop loss strategies to limit losses. They establish predetermined thresholds where they will exit the game or reduce their bets if losses exceed a certain point. Similarly, in trading, stop loss orders are used to automatically exit a trade if prices move against the expected direction. This helps limit losses and protect capital.
Example: A gambler sets a rule to stop gambling for the day if their losses reach a certain percentage of their bankroll. Similarly, a trader sets a stop loss order at a predetermined price level, ensuring that if the trade goes against them, they exit the position to limit potential losses.
While there are similarities between gambling and trading risk management strategies, it's important to note that we won’t be playing a game with purely random odds. We have an edge. However, it’s not an edge that promises a high number of winners, but winners that far outweigh the losses of a majority of losing trades. This is a critical point worth rereading.
As such, our risk management strategy requires careful attention to discipline, position sizing, and risk control, that similarly protect us from losing too much on any one trade, yet allowing winners to overcompensate.
So far we’ve covered the inevitability of silver and uranium bull runs to come, how they tend to perform and act in such times, what kinds of stocks to focus on within these markets, how to identifying inflection points that put us in the right stocks at the right times, and how to orient around risk and positioning sizing, assuming we’re highly fallible and nobody can predict the future.
It’s time to put it all together, and share my roadmap.
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