Probably the greatest discovery ever

I have to admit that I have not been a fan of mathematics since my school days. The scores on this subject were low and sometimes fell below the pass grade. I particularly had problem with the abstract calculation on advanced mathematics like algebra and calculus which after tons of brain work yet the answers are still x, y or z which fails to correlate nothing in the real world. Having said that, it does not mean I do not like mathematics though. What I need is to relate the calculation with somethings, better be tangible, that I know after hardworking then I shall get the answers that can be visualized.

I forgot the name of the man whom once said investing does not need a great mathematician. Anyone with basic understanding of simple addition, subtraction and a little multiplication will do well. I do agree with such saying because a Maths idiot like me have never come across any problem in the calculation of my investments. Unless for those who work in the Quant Investing or Algo Trading need advanced mathematical knowledge as well as programming skills, common folks with basic understanding on Maths do not need to be shied away from investing.

Having said, an extra knowledge on top of the basic mathematical calculation does help on a better informed investing decision. This knowledge is not rocket science though. Actually many of us have learned it in our college studying because Statistics is the backbone of many sciences so all graduates must have studied it no matter what subject they are major in. Despite I did have some difficult time during my study in Statistics but I did find that it is interesting because most of the issues that Stat is trying to solve are not abstract idea. In fact many terms that we come across daily are the result of statistics like average minimum wage, households income, queuing time, life expectancy...etc. They are all intimate to our daily life but not just x, y or z.

Among all knowledge within statistics, I think the concept of Probability is the most valuable piece of discovery that mankind has made ever, at least to all investors. In English, probability is about the chance of the happening or not happening in percentage or in decimal point. This is the reason I said Probability is the greatest discovery ever. In most cases, all things on earth will end up to the fact at the extreme polarity of probability of 0 or 1 where in between lies a range of ambiguity and this is the fun part of the world, ie., how likely the result will be. Excuse me for a juicy analogy that someone once said the sexiest woman is not a nude but the one with partially revealing.

In investing world, probability also plays a very important role. We all want to know what direction the Dollar is going to go say by the end of this year, the result is very simple either goes up or down but how likely it is up vs down? This is a billion dollars question and it is all about probability. Likewise, what the chance is that a particular company's debt will be defaulted is of most concern of its bond investors. For option traders, it has nothing more important than the probability of their positions will go into ITM or stay OTM no matter they are Longs or Shorts at the settlement day.

In my previous posts I wrote quite a lot relating to the importance of probability to trading is-a trade-worthwhile and the series of index-option-trading-with-statistic5. I found that probability is really the essence of the option trading because at the end of the day what a option trader cares about is whether s/he can be benefited by her/his premium received from the credit trades or by the trade profit of the long position. Unlike something on earth that probability is somewhat difficult to be determined, luckily how likely a particular strike will go ITM or OTM is rather somehow predictable so making a option trade decision is a lot more logical and reasoned. For example, based on the past settlement data, by shorting a position at a strike which is with 0.1 probability of going ITM will most likely let the trader be exposed at only 10% risk which is quite safe in the normal market situation. Naturally the risk level is completely at the trader's discretion according to his/her risk appetite but the key point is by knowing the probability it allows a trader to pick a strike under an informed decision.

As a option trader, I would say probability is probably the greatest discovery ever!