Home
IU

The Art of Probabilistic Thinking: An Introductory Guide

In the world of trading and investing, understanding the probability, randomness, and the myriad factors that can influence market events is absolutely crucial. This is the essence of ‘stochastic thinking’ – a mindset that, when harnessed correctly, can significantly enhance your decision-making processes in the face of uncertainty.

1. Embracing Probabilistic Thinking

Stochastic thinking involves the consistent application of probabilities to different outcomes. As a trader or investor, you should avoid thinking in binary terms about what will or won’t happen. Instead, consider the spectrum of possible outcomes and the probability of each. For example, rather than assert, “This stock will double in value,” a more nuanced, probabilistic view might be, “There’s a 20% chance this stock will double in value in the next 12 months.”

2. Recognising the Role of Randomness

Understanding the role of randomness is another key aspect of stochastic thinking. Past performance can be a guide, but it doesn’t guarantee future results. Each market event is influenced by a host of variables, some of which are random. Recognising the inherent randomness in markets can help you maintain realistic expectations and mitigate the risk of losses.

3. Expecting Variation in Outcomes

Stochastic thinkers appreciate that outcomes can vary and that there’s usually a range of potential outcomes. When forecasting the future performance of an asset, it’s prudent to consider multiple scenarios. You might think about what could happen in an optimistic scenario, a pessimistic scenario, and several scenarios in-between.

4. Regularly Updating Beliefs

Consistently updating your beliefs based on new information is a vital part of stochastic thinking. If you initially thought there was a 70% chance a certain stock would increase in value, but then new data came to light that made the future seem less promising, you might revise your estimate down to a 40% chance.

“The moral is that in trading it’s important to examine the situation from as many angles as possible, because your initial impulses are probably going to be wrong. There is never any money to be made in the obvious conclusions.” – Jeff Yass

sc name=”fma-cta”]

BLOOMBERG GLOBAL NEWS

Bloomberg video news feed with live charts, watchlists & fundamentals
Audio/video feed with live charts, watchlists & fundamentals
CHARTS + FEED

RBA ECONOMIC UPDATES

Periodic updates on the Australian economy, direct from the RBA, with live charts, watchlists & fundamentals
Audio/video feed with live charts, watchlists & fundamentals
CHARTS + FEED

US FEDERAL RESERVE UPDATES

Bloomberg News focussed upon the Federal Reserve, with live charts, watchlists & fundamentals
Audio/video feed with live charts, watchlists & fundamentals
CHARTS + FEED

FX/GLOBAL BRIEFS

Brief global updates with a focus upon currencies, with live charts, watchlists & fundamentals
Audio/video feed with live charts, watchlists & fundamentals
CHARTS + FEED

ASX MARKET UPDATES

ASX-focussed updates, with live charts, watchlists & fundamentals
Audio/video feed with live charts, watchlists & fundamentals
CHARTS + FEED

BLOOMBERG BRIEFS

Global briefs from Bloomberg with live charts, watchlists & fundamentals
Audio/video feed with live charts, watchlists & fundamentals
CHARTS + FEED