Ep 112: Trading Stocks by the Numbers (Statistical Probabilities + Options)

December 1st, 2016

Listen to the Podcast

Subscribe to the podcast

iTunes Stitcher

In this week lesson, we're going through trading stocks by the numbers and looking at statistical probabilities.

Disclaimer

I do want to remind you that all the examples that we use in this video or any other videos are strictly just there for informational and educational purposes. None of it is recommendations to buy or sell any stock securities or options. That's because you might be reading this that some future date and time or your risk profile or risk levels might be different.

A Few Words about Live Classes

Visit traders fly website and check live classes towards the top. My ideal goal is that we take this live class concept and apply it to live market conditions and do trading.

You'll see there's a calendar of events. You can even mention some stocks, and we can look at them and dissect them and evaluate the charts.

Log into your account. The registration is free; it's just to get the notification email of where to go to watch the class. Choose what suit you the most and enjoy learning new things.

We're going to get into very detailed concepts if everything lines up and if you like the live classes. I'm looking to take 1, 3, or 4 months depending on the trade selection and go through the trade with you on a week-to-week basis.

I'm going to show you:

  • what I do
  • how to trade select

And you can watch the class, or you could follow along. It's going to be up to you, but it would be in the live market conditions. That way, you can see how to do retirement trading or build for your retirement and a simple vertical strategy.

Most of these are going to be free. As we get into detailed classes, some of them will be more premium based and more paid based.

Some of the topics might be something like this:

  • beginners for trading stocks
  • detailed trading for retirement with options
  • long-term investing strategies

In either case, take a look at those things if you're interested. Make sure you register your seat.

Focusing on Our Charts

Take a look at our charts right now and get into statistical probabilities and the chances of things working out. I'm going to do this in two different ways. The main reason for doing this is everybody's trading a little bit differently.

You see that the market right now is starting to roll over.

You see this topping action, and when you have an expansion that's this far, it's pretty dramatic.

More than likely a slight pullback should happen even if we come back to retest this price level. One of the things that I typically like to watch is I look at things like the Amazon. I watch how they're performing.

Also, I take a look at Apple, Netflix, and Facebook. When I see these significant companies rolling over to me, this is a little bit of a caution sign.

It is when the leaders don't lead, there's something underneath, that's changing. This could be good, or it could be for a bad thing. When I look at Facebook right here for a $3.50 move about in a day - that's pretty significant.

That means volatility, and the stock is picking up. Now granted some of this was due to the earnings problems that they had. They talked about it, but if that stock that level breaks down then more than likely we will see lower prices.

As you could see here, the volume is also picking up. Take note of that and be very careful, especially as you see these big companies pushing lower.

When it comes to Amazon, you can see the ABCD pattern. As you look at this, you can see that we're hitting this 61.8% level. And we couldn't fill the gap.

  • What are stocks going to do?

If they can't push it higher, they'll bring it back lower. We're looking in evaluating any stock chart. You're looking at the chance of something happening.

And in the day-to-day world, the chance of something happening is not that difficult to understand. As you get deeper into statistical probabilities, it does start to play a more significant role.

In this case, I'm going to look at two different types of statistical probabilities.

Statistical Probabilities

The first one is we're going to look at some statistical probabilities. As I look at things on this page, for example, it's elementary to look at statistical probabilities.

Here I have a few different index cards in yellowish tone - 5 of them. Then I have a pink one on the right.

I started to mix these up. Now, if I took somebody that was blindfolded, what the chance or which card color has a higher chance of being picked is.

To remind you there are five orange ones and you have one that is pink. It's a pretty simple answer. These yellow cards would be more likely to be chosen. At least one of the yellow ones is more likely to be selected.

As I take one away, the chance starts to diminish a bit. And as I start adding pink ones, we can have three pink cards at this moment. Then your chance begins to become a little more balanced.

If I add a fourth one now, you have a 50%-50% chance for those things to be chosen. In the stock market, things are a little bit more complicated.

Think about the rubber band effect. If stock market prices go up a little too high eventually they'll snap back down. The same thing if they go down a little bit too much eventually they'll snap back down.

That's why if you have a significant sell-off that's big eventually have significant snapback that's also more strong to the upside. And the same thing if you have a considerable pop to the upside finally you have a major pullback as well.

Sometimes those things can work out a little bit differently, especially if you have a significant pop to the upside. If you get some sideways consolidation or sideways action, this can help ease the pain as well. If it moves sideways, that builds momentum for it to snap more to the upside or the downside.

The same thing works in reverse. Let's say stock market it's moving to the downside and then if you get some sideways action it's building or even a little retracement to the upside - that snapback down can be even more violent.

Some critical support levels get broken. If they get too far stretched, that band will snap. It will continue selling off. Remember, the more stretch, and the more coiled this thing is either down or up, the bigger the snapback.

With that in mind, as we look at probabilities, this is what you're looking at. You're looking at stock prices.

Closer Look at Amazon

As we look at Amazon, you can see when the stock gets sold off in a big way you probably get that snapback.

That's why you have the ABCD pattern. You got a snapback, but the snapback isn't as big. That's because the coil is set up for downside movement.

After that snapback, you're getting that next leg to the downside. When you get too far extended to one direction, it'll snap back in the other direction. That's why in general are 90% of traders wrong.

That happens because when they see this sell-off happening they say that's the market or this stock is going down.

They estimate the stock is going down. Then probably what they do is go short at this price level and then all of a sudden it reverses. You get that reversal and the wrong. They get out - they lose a lot of money. That's what happens.

If you're looking at the upside, it's the same thing. After a while, it's starting to go up. And people think that is great. It's going up, and then they wait another day or two. They are waiting for the right moment to get in it at this price point. And then eventually we recoil back and snap back because we're too far extended to the upside at this level.

You look down here, and you'll see that we're too far extended to the downside. It depends on the time frame view. You could have a shorter time frame view (daily or 30 minutes), but you usually want to look at daily, weekly, and monthly.

The concept is there no matter what frame view you apply. As you get too far extended probably should get a pullback. On the other hand, if you get a pullback that lasts 1-2 months, you probably will get some higher prices.

As you think about it more deeply, you start to put those things together. This helps increase your statistical probabilities as you start looking at things. More things are in your favor.

Look at this ABCD pattern. If you're in the trade or getting in the trade, you wouldn't know that this trade is setting up for an ABCD pattern.

You wouldn't know until this bounce over at this price level. But you could start seeing things. You have this expansion, and when you're at this point (B), you notice that it's a little extended.

Now you see the price expansions a little high, so you would want to wait for a pullback. While everybody else is selling you know that here your C point you have a pullback. A standard pullback can go 50% and have nothing wrong with the stock.

Pro tip: You can have a pullback 50% (even 61.8%), and nothing be wrong with that stock.

Right now, we have this pullback. Everybody's selling, and most people are wrong. Instead, you would probably want to be buying on a big candle like this. Now you want to be very cautious and going slowly maybe do it over multiple days.

But typically this is the concept. You're doing things opposite of what you usually think. It's something like when you're driving or eating. For many people, they do the intuitive thing.

You want to do the counterintuitive thing. Things that usually are not natural to you, and this is why this works out.

Many people are selling, and you should be the buyer. As you're doing the buying right here in this bar (C), you'll slowly see that bounce come in. That's where you get that full expansion.

There're a couple of things in your favor. As I look at this, you see that you have the A to B pattern and the stock was overextended. Now, you want to wait, and you're getting the pullback there, and you see the B to C pattern. That's two things in your favor.

Then you're looking for:

  • the volume
  • the contraction of volume
  • how the stock is moving
  • the shift other factors

If we're on the weekly, we can see it's 50 a week. You see how does that come into that. It broke it a little bit, but it's holding it.

The volume here is not in as big of our favor for the upside. But we did get the pullback. You have to balance those things out.

As you start seeing more and more things you're putting that statistical probability in your favor. That's what you want to do as you look at prices.

Evaluation of Probabilities

When we look at this on a piece of paper, you can start evaluating these probabilities.

There're a few questions:

  1. is the stock overextended?
  2. what patterns do you have?
  3. does volume confirms the move?
  4. the health of the market?
  5. what about fundamental analysis?

1 - Is the stock overextended?

It doesn't matter if the stock is overextended to the downside or the upside. If it's overextended, then it's not in your favor to go into that extension. That means if we're too far to the downside and you want to go short, that's not the right approach. It's not because you're overextended. If it's overextended to the upside and you want to be the guy that goes long typically, that's again not in your favor.

2 - What patterns do you have?

The second thing is what patterns do you have. I'm making a simplistic approach here. When you're looking for the upside, do you have an A to B pattern? Now we're overextended here and are you getting a slight pullback? Are you in the B to C leg or are you creating maybe a triangle pattern? Maybe there's a consolidation. Did you have a consolidating base or some contraction? Where are you relative to the previous up move? Is this in your favor as far as the pattern goes?

3 - Does volume confirms the move?

Number three is volume. When you look at this pattern, does volume confirm the move? Do you have more volume here to the upside and less volume on the retracement? Check where you have more volume. Let them take some profits so that way you can have that next leg higher.

If you have way more volume on the downside then on the upside, then more than likely this pattern will break. More than likely, this support at this level will break and continue lower. You check in the volume. If it's a little more even that could happen depending on market conditions. But you're looking for volume dying out.

That means as we go up, you want nice significant volume. You want multiple bars that are nice and big. And as you pull back before you take the next leg higher, you want lighter volume. Now, this is again a simple example that I'm showing you. It's a 50% reduction in volume. Most of the time you'll see it won't be that easy to spot.

Pro tip: You have to compare the bars and look at them individually. You're looking for a reduction of volume so that way as you start breaking out you'd want more volume. That's ultimately the traditional way or classic approach.

Now you have three things that you're looking for in your favor. That's all getting things to set up. If you only have two of these, then you have less stuff in your favor. But if you have three of these things, then you have more things in your favor.

4 - Health of the market?

Then you start looking at other factors - the health of the market. If you look at the health of the market, this could be another thing. If your stock is heading higher, but the market is heading lower, that's not great. If you don't have both things in alignment, then one less thing is in your favor.

My way of doing things:

This is what I do. I probably have a checklist of ten different things that I'm looking at as I continue running through this. There're a lot of other little minuscule things. On this list are main things that you're starting to look for and you'll start building upon that.

5 - What about fundamental analysis?

You'll also look at fundamentals. If you're trading the SPX, SPY and so on you, don't have to worry really about fundamental analysis or even earnings. The reason is that because there's no fundamental analysis. It's a group of stocks, so it makes it a little bit easier.

In that case, makes your life easier you don't have to worry about. But in general, that's what you're doing. You're starting to add more things together.

Benefits of Options

Now even if you're trading regular stocks, you can use the benefit of options also to give you a chance or probability of success. And you are looking at those probabilities.

Here with Amazon as I start looking at it - you can backtrack it on the monthly, and you start viewing things. Again you can do a long-term pattern. And you can do shorter term patterns.

There is ABCD pattern within the ABCD pattern. You're starting to look at those things. As you backtrack it into the weekly, you start looking at those other things as well. You got the big-picture view, and as you get into the big picture, you begin dwindling into the smaller items.

You start looking at the volume and expansion. You're looking at how are things looking overall on the SPX.

  • Is the SPX or the SPY or the Dow Jones also a little toppy?
  • How's the volume?

As we go to the upside, the volume was pretty good. But look at the volume then later. As you start looking at this and we look at this volume on the red bars, they're starting to pick up. It's beginning to roll over.

  • Can we move here and move sideways and then power higher?

That's possible. But this means one less thing in my favor.

Closer Look at Facebook

I'm taking Facebook as an example. The Facebook stock itself is stretched, and there hasn't been a pullback in a while.

I'm looking at:

  • a pattern
  • support lines
  • the volume

As you start putting all those things together, you start realizing what is in your best interest.

Maybe it's not in your best interest to go long. But it's starting to get there because now you can see the market is beginning to pull back. So if the market pulls back and it's a little overextended that'll probably start getting into a good value. But in either case, let's say this is a fair value.

Let's say 50% on this stock from the breakout would put this stock somewhere around 77. You won't always get a perfect entry on these stocks. Sometimes if it comes down to this price level now, these price levels become even more in your favor.

That's the case becomes now you have a pullback. And overall, the trend is upward. If you have a slight pullback, then there's no reason why the odds aren't more in your favor because you're buying it at more of a value.

That's what you're looking for. The more things you have lined up, the better it is for.

How Do You Use Options?

You are wondering how to use options to give you some price indication or probabilities of things working out. Well, if you look at Facebook, we're at basically 114.83. We're not going into detail of how options are priced.

But take a look at think or swim platform or any platform that gives you statistical probabilities. I pull up Facebook, and you can see that you have the calls and the puts.

Let's say we're looking for the 130 price level. You can see I have the probability of in the money. And you can change these values. I have a probability of in the money set for this column, and it's set on the put side as well.

That's my probability of in the money. This is at expiration, not touching, but at expiration, if that option premium is worth any money.

The chance of this expiring in 50 days above 120 is around 31.17%. That's above 120. As I look at this price above 120, you got about 31% of it expiring in-the-money. That is giving you 30-70 odds. Not the best odds, but it takes time for those things to come back and reverse.

You have to take that into account. As you switch and getting into the money, you got a 65% chance even though this is at 110 and the stock is at 114. This is already worth something, but the time has not expired yet.

This gives you a rough indication, but it's not about touching it. I believe they also have of touching. As you go into touching, you can see the probabilities jump. That's because it's touching it.

If you're looking for price movement and selling it out there, you could use the probability of touching. You can see at the 120 you got a 63% chance, and at 115 you got a 99.9% chance.

And at 114 you have 98%. You can see those probabilities already shifting and changing and hopping and jumping. If you go to the downside, you can do the same thing. It's possible for you to see the probability of touching. You have 17.72% at 97.5.

If you're shorting a stock and you're expecting it to get to 85 within 50 days you technically only have about a 5% chance.

  • Can it happen?

Absolutely, but you only have about a 5% chance of it getting to 85.

Let's say you shorted the stock. This right here we have a 5% chance. As we short the stock right here and it starts heading lower, your chance starts to increase. That 5% may get to 12%.

However, you have to remember where you start it. You started up here at the 115 level. So your chance slowly started diminishing because you're going to get it bounced sometime in the future. You need to be taking profits somewhere over at this price level.

It's smart to start getting out of that because you were at higher prices. The chance is starting to go against you now. The reason is that you're going to get that counter-trend rubber band to bounce effect.

That's how options help you look at those chances of success and probabilities. The same thing is to the upside. If you're buying 50-100 shares and you're looking at this your chance of getting to 125 in the next 50 days and touching it you got about a 35% chance.

It gives you a rough indication. Now if you get into the 120, you got about a 63% chance. If you're looking to get $5 out of Facebook, you have a higher probability of success.

Maybe you're trying to be a little more greedy. And you're trying to get 130-135 on the price level in 50 days, and your chance of success goes down.

You can play the chance of success versus profitability. If you have a higher chance of success, you make less money - but you have a higher chance of success.

If you are more greedy or if you want to make more money, you have a lower chance of success, but you can make more money.

It's a trade-off and a balancing effect that you have to do as you start looking at these things personally. You can use options to help you out with that. But in general, you're combining multiple things.

You can use Bollinger Bands to help you with the over-expansion. You can see you at the upper range or are you towards the lower range.

These contract and expand as you get into more volatile or larger price bars. You could use that as a guide. You can draw them with a moving average.

That's what you're looking at when it comes to statistical probabilities. The green line is that expiration. The white line is the current profit and loss picture.

We're at 114.96. If we're above 100, we make $28. We're risking $472 to make $28 which is not a lot. But your chance of success is higher.

I could pull this into 110 and 105, and now I'm making 109 on a $391 investment or risk. I'm making much more on the absolute dollar value, but my chance of success is a lot smaller.

Final Word

Take that into account as you start balancing and looking at your positions and trades. You have to take into account the probability or chance of success along with your risk tolerance.

You can make much more if you take the higher risk. I hope you enjoy this lesson on statistical probability and that you have an idea when it comes to trading stocks by the numbers.

Author: Sasha Evdakov

Sasha is the creator of the Tradersfly and Rise2Learn. He focuses on high-level education speaking at events, writing books, and publishing video courses on business development, internet marketing, finance, and personal growth.

I'm Sasha, an educational entrepreneur and a stock trader. In addition to running my own online businesses, I also enjoy trading stocks and helping the individual investor understand the stock market. Let me share with you some techniques & concepts that I used over the last 10+ years to give you that edge in the market. Learn More

Join over 31,258 regular people who are bettering themselves in the stock market.

Click Here to Sign Up!

This is a community that is motivated to learn & improve their skills.
Join us and get free training lessons, freebies, and exclusive promotions.

want some helpful advice?

pay per minute coaching

I am scheduling helpful coaching sessions for people who are interested in real-world advice & guidance where you only pay per session. No long term commitment required.

Learn more
This website and content is for information purposes only as Rise2Learn, TradersFly, and Sasha Evdakov are NOT registered as a securities broker-dealer nor an investment adviser. No information herein is intended as securities brokerage, investment, tax, accounting or legal advice, as an offer or solicitation of an offer to sell or buy, or as an endorsement, recommendation or sponsorship of any company, security or fund. Rise2Learn, TradersFly, and Sasha Evdakov cannot and does not assess, verify or guarantee the adequacy, accuracy or completeness of any information, the suitability or profitability of any particular investment, or the potential value of any investment or informational source. The reader bears responsibility for his/her own investment research and decisions, should seek the advice of a qualified securities professional before making any investment, and investigate and fully understand any and all risks before investing. Rise2Learn, TradersFly, and Sasha Evdakov in no way warrants the solvency, financial condition, or investment advisability of any of the securities mentioned in communications or websites. In addition, Rise2Learn, TradersFly, and Sasha Evdakov accepts no liability whatsoever for any direct or consequential loss arising from any use of this information. This information is not intended to be used as the sole basis of any investment decision, nor should it be construed as advice designed to meet the investment needs of any particular investor. Past performance is not necessarily indicative of future returns.