Buy low, sell high.
That’s the goal of most traders, particularly those that trade stocks. And it is why most individual traders fail.
Picking the direction of the stock is, well, difficult. It’s a 50/50 bet. Yet even with those low odds, the vast majority of investors put their hard-earned money into stocks.
It’s an exercise in futility. And statisticians have a name for it: The Law of Variance.
It works like this: The more stock trades you place, the closer and closer you will come to a success rate of 50%.
Which leads me to a far better alternative that puts The Law of Variance on your side: options.
Options trading isn’t about whether a stock goes up or down. It’s about using the probability that a stock will remain in a given trading range. Trading this way gives you the edge of a casino or insurance company.
You see, casinos and insurance companies profit from The Law of Variance too.
Casinos collect small bets over a long period of time. As the number of bets increase, the statistical odds of success fall in line with each respective game.
And the casinos always put themselves on the right side of those odds. The best possible odds for the individual gamblers are craps and blackjack at just under 50% . . . meaning that over time, the casinos win more than half the time.
As for insurance companies, well, the same concept applies.
Insurance companies exist because they protect something of value for a fee or premium. For instance, they know that most homes won’t burn to the ground. And the policies they sell for a premium exceed their risk over time. Again, The Law of Variance at play.
Most people never file large claims. That’s why one of the best investors in the world, Warren Buffett, runs an insurance company. He understands the basic principles of probabilities and The Law of Variance.
Our options trades put both probability and The Law of Variance in our favor. Both are statistical certainties.
My options trading recommendations use strategies that have an 80% probability of success. We can expect over time that our win ratio will follow suit. In 2018 we made 66 total trades, with only 8 losers. That’s a win rate of just under 88%.
And we take one more cue from casinos and insurance companies: risk management.
Think about it. Insurance companies don’t risk everything by selling a large premium on one policy. They sell millions of policies. Just like casinos don’t allow just one gambler to come in and place a huge bet. The allow millions of gamblers to make bets.
Both insurance companies and casinos are making small profits over many occurrences so that the probabilities and The Law of Variance play out.
The same goes for options trading . . .
By using strategies with an 80% probability of success and placing reasonably-sized trades, we know that over-time, the statistics will play out and we will be profitable.
It’s a powerful concept and one that will transform your investing approach forever.