Probability in Finance - Statistics For The Trading Floor - Quantitative Methods
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- čas přidán 29. 07. 2020
- Today we discuss probability in finance and why it is important for investors to have a good understanding of probability theory. Probability theory is widely applicable in all areas of finance. Probability allows financial professionals to calculate things like expected value and to price derivatives. The expected value of an investment is simply the probabilities of the various outcomes multiplied by the various payoffs in the different scenarios. Probability is used everywhere from valuing a simple equity investment, to pricing exotic derivatives. The insurance industry is almost entirely built upon probability calculations, and an important component of credit is the probability a loan will be repaid.
In Patrick Boyles' book “Statistics For The Trading Floor” (available at this link amzn.to/3fcQrIK) he works through all of the important probability calculations and how quantitative methods can be applied in stock market analysis.
In the video Patrick mentions professional poker player Annie Duke and her book Thinking in Bets, available at this link. amzn.to/33bnt9F
Patricks' Books:
Statistics for Traders: amzn.to/3eerLA0
Financial Derivatives: amzn.to/3kwsPSr
Corporate Finance: amzn.to/3fn3rvC
Visit our website: www.onfinance.org
Follow Patrick on Twitter Here: / patrickeboyle
Patreon Page: / patrickboyleonfinance
I see you scrolling down. Don't forget to hit the subscribe button first!
already did, of course!
i did
This is gold. Thank you
Personally, I'm always worried there's something I'm missing that will come around to bite me. Are there any signs to look for that might indicate my successes are random? I follow a system most of the time, but are random successes fooling me into thinking my system works?
You got me, I just subscribed.
Extremely succinct summary. I'm a Computer Science/Math student currently studying for quant interviews and have found your lectures very helpful. Currently reading your book on corporate finance as well.
Wow, thank you!
If more people understood probability (and its inverse, statistics) on an intuitive level, I think virtually every aspect of civilization would be different, and for the better. I will continue to advocate for probability education for developers, and publish courses on this. And I applaud you for doing the same for finance/business fields.
Thanks Quincy.
Whaaaaat I really didn't expect to see you here! Thanks for the great content and I look forward to the fcc emails every week! Btw I just saw the data science curriculum. So excited!
That's the first time that I've heard statistics as being the inverse of probability. And that makes sense.
Finally, somebody saying statistics is invers probabiloty ^^
"Being a statistician means never having to say you're certain."
Wow, this makes me realise how smart Paul the Octopus really was...
So true...is Paul dead?
@@availablehage Born 2008, died 2010 .. yes, its dead
Excellent stuff here. I always enjoy learning about mathematics and probability when its relation with risk, markets, wagering, and everyday decisions. Especially when the instructor is Jason Statham.
Im a high school student studying statistics and how it relates to quantitative trading and this video was helpful! I still need more practice so your videos help out a lot! :)
As a day trader I learned all about statistics. Especially “regression towards the mean.”
Thanks for another great video Patrick. I look forward to each one you do.
Excellent brief explanation. I will use this in my biology class to explain probabilities of Covid-19 outcomes.
Incredibly intelligent approach to the subject and its realistic application
Wow i cannot thank you enough for how you solidify my views of the market after listening to you on a podcast in exposing the fake financial gurus I stay watching your CZcams in your interview with the author which is your colleague that wrote the book WOW I AM IMPRESSED
Got your book. It’s exactly what I was looking for!
Top video! Many thanks, Patrick!
Geez, I'm thinking I fully deserve a book discount code for loyally watching an entire Jeff Bishop/Raging Bull ad before this video ! I have one Patrick book already, Corporate Finance. It is one of the most honest, informative, well written financial books I have ever read, trust me, I'm not a stockbroker ! I want another Patrick book, but, which one......
I've subscribed to this channel. My goal is understand and apply the theory of probability in my everyday decision-making.
Brilliant video! Every serious investor should watch this!
Thanks, glad you enjoyed it.
The Duke book mentioned is excellent.
Thanks, this is an amazing video.
Great video!
Excellent clip.
Nice video again. Thanks for such great content
Great explanation!
very interesting...thanks
Great video, I will definitely buy your book
Your book is on the way. Really interested to see how statistical methods are applied in finance.
Brilliant presentation.
Thank you professor
Your channel is excellent sir. I will try your book
Nice Rolex explorer Ii Patrick
excwelent video don patrick
best explanation of probability
Hey Patrick, I love your content. And the reading list you recommends! I would love to see more practical case studies!
2:49-3:43 was why I hit Subscribed.
@patrickboyle finding your videos interesting with refreshing dry humour! Thank you. With regards to your book Statistics For The Trading Floor ... is it also applicable and useful for forex market trading?
thanks sir
There is a fine line between what you think will happen, and what you want to happen.
Know someone who graduated from a college business program. He believes that the financial markets are tied to the companies' operations to a large extent... to the point that reading many business journals & company financial reports can predict stock prices. Some people feel better to think that playing the market and "investing" money is the same thing that require a lot of research & planning. Instead of saying there is uncertainty involved like "gambling" in a casino. Investors don't like to think of themselves as gamblers.
An unlucky person invested money into Enron and held the shares to the end... even bought more shares the last minute to bring down the "average cost" while ignoring the probability the company could go bust vs. stock prices having a correction.
Look at market efficiency hypothesis.
Thank you for taking time from your busy schedule to provide such high quality content
can you please recommend some trusted recent statistics books about trading strategies back-testing & win rates, it would be better if they focus on Futures day-trading strategies.
@@wion7045 You're a smart indian SOB lol
Love your video's! I am subscribed. I'm curious, assuming that all stocks have some degree of volatility, how does fundamental analysis factor in the volatility of a particular stock when, it is my understanding, that fundamental analysis arrives at a deterministic valuation? Or is a simulation analysis conducted on the fundamental analysis to arrive at a distribution of valuations? I've wondered this for some time.
Fascinating
Go Get it.
Hey. I realised what kind of investor I am and what can of risks I can tolerate. I release that I am better off choosing 3 or fewer stocks and go really deep, buy as much as i can while the price is favourable. I like to own a lot of something i like rather than spread it around. I realised that when i had owned shares in 5 companies and decided which of these do I like so much I want more of. Thinking like like i sold my position in 2 stocks and grew in 1 stock. i now have 3:2:1 ratio in the three stocks if I look at the amount invested. IF one of my stocks reach a minimum share price, I will likely sell it and grow my position in one stock, provided that the price is still favourable for that stock. I realised i would rather have more of this stock instead of keeping my position in another company I own.
Patrick I am now a huge fan. Now on the topic:
I used to be fascinated by the poker world, it's mathematics and dynamics. I read over 20 poker books, all considered a must-read. To those interested, this list by itself is gold....
Harrington's Tournament strategies, all 3 volumes
Sklansky Theory of Poker
Sklansky Theory and Practice
Gordon's Little Green and Blue Books
That Danish(or Swedish) guy, forgot his name, the very good looking guy, that had a whole book documenting each hand in winning a whole tournament
I got video lessons by Howard Lederer, Phil Helmut, Todd Bronson, Annie Duke etc....
....
(Don't get me wrong from it is about to follow, some of their math such as odds of hitting winning hand, pre-flop analysis and other canned math, was very educational..... BUT)
What I realized is that they all seemed to overestimate their ability to estimate the odds of something happening.
For instance, they would throw these examples:
"Because I estimated that this guy was passive-aggressive, I had about him being 35-40% holding , J-10 to K-J type of hand". I can think of many examples where they had these probabilities split into 3 cases (20% - 70% - 30%) where the opponent would have a range of hands in each of 3 cases. It was very easy to think of counter examples, where, if the "Poker Superstar" was off by 15% then they would actually be making a statistical blunder(by their own definitions). And the reality is that it is very hard(or impossible) to come up with these probabilities. Basically they will start with some completely out-of-the-thin-air assumptions, and then will carry out VERY CORRECTLY and SCIENTIFICALLY THE CALCULATIONS that would serve as the "correct" decision. And if you think about it , it is very easy to mis-price those odds!
The more I read these books, and I read the top 5-6 books 3-4 times each, the more I realized that it the whole thing was a rather indirect example of confirmation bias mixed with selectivity bias.
Years after my poker obsession, I realized what was happening. Those poker players were not successful because they were estimating correctly odds. And what I am going to say here is very eye-opening..... In the middle of a heated hand those guys will take their mind AWAY from the emotions on the table, they will carry their math in their head, and despite the math being super flawed, it served as a tool to be non-emotional and cool-minded. It was their get-away drug, drug that would unintentionally serve as Xanex for them. Think about it, the more you slow down time, and start doing some mental math, the more, your heart-rate will drop, and emotions will subside. And cool heads would always prevail especially on poker table.... Tilt would be avoided unintentionally....
With all this being said I think this can serve as an amazing example of what is needed in trading. Approach trading, and life, with cool head and where you can assess situations EMOTIONLESS.
If calculating fictitious odds makes you more confident and calm - do it in middle of trades.
If size of bets is the emotionally contributing factor - assess bet-sizing and not the odds of winning.
Trade-sizing should be such that winning OR losing brings the same emotionless state.
It is ALL ABOUT PSYCHOLOGY(AND EMOTIONAL CONTROL), AND LESS ABOUT ODDS, IN MY OPINION.
I find myself using my knowledge of probability in everything. From stocks to games lmao. While it’s true when too much knowledge of a bad rate stops you from playing, but in the long run it does save you a lot of money. And if you’re lucky, you might even win some money
Listen and learn guys!
AAA+++, KEEP UP THE GOOD WORK
That’s for the insight
nice one
Thanks
As a professional poker player I absolutely agree. I have played over 10 millions poker games and was never negative after million games played. Let me ask you next. In what period of time, your fund can place enough numbers of bets, to have 95% probability of return => 7%?
Hi Patrick. Just bought Statistics for the Trading Floor! The bad thing is that I live in Costa Rica and will take like a month to get here because of COVID.
Ha Ha. I had the same problem waiting for my personal copy. The postman was getting tired of me every morning checking to see if it had arrived yet. Hopefully you will enjoy it.
Patrick Boyle I can imagine it lol. I'm half way trough “Security Analysis” so I have something to distract my self for the next couple of weeks, after that I will be calling the post office as well haha.
mmm very good video
I work in the healthcare field, and this totally exemplifies how people think about medicine and disease too. The public thinks a pill or medicine or doctor “failed” if they don’t get totally better. And it’s like…no, you had a 75% chance of some improvement. But you were part of the 25% that didn’t. 🤦♀️. It does not reflect necessarily on the competence of the provider nor necessarily how severe your illness was.
Thank you for your clear and down-to-earth explanations.
* Is "Statistics for the Trading Floor" available in electronic format?
* It would be nice if your statistics book (Amazon's "Look Inside") included one or more examples explaining how to do an actual statistical technique, such as "How to Conduct a Linear Regression".
no YOU have a great day
Also common misconception: a probability of p=0 does not imply that the event in question can’t happen. For both frequentisit or bayesians perspective.
Surely by definition if zero then can no occur?
@@annajones9701 Taka a coinflip for example. What is the probablility of an infinite number of heads or tails in a row? p=0. But it is possible. Here is a nice example: nolaymanleftbehind.wordpress.com/2011/07/13/the-difference-between-impossible-and-zero-probability/
@@davidjohansson1416 I would not state that as zero probability. As still possible, but tending to zero is not same as actually zero. Actually zero would be probability getting neither head or tails and is an event that can not happen.
@@annajones9701 "Probable!=Possible" Probability is a measure of an event and it's "occurance" described by a probability function with an "input" of an event. So zero probability is not same as "not mesurable" or not in the event space. An event can be lacking in sample, giving a measure of zero but still being in event space with prob.=0.
Well maybe imagine all real numbers on a number "line"(continuous), then pick any number. What is the probability of picking EXACTLY that number if the probability of of them are uniformly distributed? The answer is 0 not "close to" or "very small". If you really want to convince youself of this there might be a good idéa to read about Lebesgue measure. Or other measure theory about the difference between "empty" set and an event with probability zero, but Still "included" in the event space. en.wikipedia.org/wiki/Probability_space
OR:
"Under the usual measure-theoretic formulation of probability theory, we have a sample space Ω and a family F⊆P(Ω) of events (measurable subsets of Ω), and the probability of an event A∈F is its measure P(A). There is nothing in the axioms of measure theory which say that a non-empty set must have a non-zero measure; and if we interpret F as the set of all possible events, it's clear that an impossible event is not the same thing as an event of zero probability." math.stackexchange.com/questions/41107/zero-probability-and-impossibility
@@davidjohansson1416 Good explanation David. I take it you are a math major. Probability certainly has its real world applications and distinct from theoretical applications.
Good video! Thanks
I know this video is a year old. But could you possibly do a mathematical example in a video? I know you said you have your book (which is now on my read least). But I would really like to see it done out live to get a better understanding
I'm going to buy all 3 of your books. Im more of a swing/day trader, which one best relates to what I do. Thank you
All three are appropriate for a trader, but the derivatives book and the statistics books are the most suitable. Amazon has a few versions of my derivatives book listed, but this is the one to buy as it is the latest edition and cheaper than the other versions. amzn.to/2HLSet8
@@PBoyle
Noted. Thank You
Great video Patrick. In the coin toss scenario, is the chance/probability of having two heads on both coins a result of its place in the total possible outcomes (1/4) or its place in a substantial number of rolls (lets say n=100)?
When a coin is tossed, there are two possible outcomes, heads or tails. If two coins are flipped, there can be two heads, two tails, a head and a tail or a tail and a head. Each of these outcomes is equally likely, so there is a one in four chance of HH, one in four chance of TT, and a two in four chance of a head and a tails. The number of possible outcomes gets greater with the increased number of coins.
The multiplication rule is how we calculate the probability of two events happening at the same time. There are two multiplication rules. The general multiplication rule formula is: P(A ∩ B) = P(A) P(B|A) and the specific multiplication rule is P(A and B) = P(A) * P(B). P(B|A) means “the probability of A happening given that B has occurred”.
@@PBoyle Thank you sir
There are two types of people:
Those who think that rain today, means that rain tomorrow is MORE likely, and
those who think that rain today, means that rain tomorrow is LESS likely.
Hallo Patric,
since I am no profesional Trader/Investor, your book is probablly not best fit right now for a beginner trader(a student of somputer engineering) like me. If you happen to see this comment, could you maybe recommend some other books to learn first before reading your book(I could probablly google what books are a good read but I trust you more). Thanks !
Hi Mateo, I put a video up about a month ago listing my top ten favourite finance books. You should be able to find something on that list that would interest you.
3rd Fury brother
The first thirty seconds were actually terrifying
why don't you offer your books in a kindle format
omg i hate you, i just updated my wireless headset(cause it had some volume issues) and i was like hmm let me play a video to see if the issue is still there... i was used to your voice from the rest of your videos so when clicking to play the start i thought there was no way my headset's sound got worse... thanks for the awesome video, great information, (i dont really hate u
I still have no clue how this relates to stock picks. This seems like market analysis or something applicable to broader economic prediction.
He could have more directly Linked the two concepts with examples in the vid.
I interpret it like- If a person sees a stock go down 20 days in a row, their brain wants to say, oh we should buy that because there’s a large chance it will go up tomorrow, because it’s been down so many time in a Row- what’s the chance It would go down again 21 times down in a row?
But that’s the coin flipping fallacy. The odds of the stock going up or down are, from a binary standpoint, 50/50.
And if you still feel in your soul it will go up tomorrow you buy today and it goes up, remind yourself that this is likely more luck/probability, than skill. Don’t get suckered into thinking you have a genius strategy, when this was more likely related to luck or chance.
Probability can help you win in the stock market if you stack the odds in your favor. So when doing a trade, if you plan to exit at +10% profit or -5% for stop loss/risk, your profit/loss is 2:1. So you will lose trades. 1/3rd (if not more!) But hopefully you also win 2/3 of the time because of how you used probability to your advantage.
Its referred to as results oriented,” not resulting.
Sir, Assuming forex pair prices are random--how often do you think currency reaches past value of daily ADR from opening price(5PM EST) on one given day either up or down--if percentages are low,then trader can make money by just limit orders put in at start of every day(win/lose).Put(for example) buy orders 80%(of ADR) below EOD(end of day)price & stop loss past distance where pair is unlikely to reach most of the times. At the end of day cancel unfilled orders & new orders are entered according to new EOD prices.Vice versa for sell orders.Stop loss reversal order is at where market is unlikely to go most of the times.Seek your wisdom.
Probability has memory - if you have too many heads in a row, tails is more likely to be next.
Are you serious when you make this comment about memory?
It is possible to flip a coin 10 times and get a heads or tails all ten times. Each toss is random and as long as the coin is made and flipped properly has a 50% chance of a heads or tails.. A previous toss doesnt have an impact on a future toss.
@@nemoretime7466 ofc I wasn't serious lol "memory"
@@TheGargalon Thats ok I just wondered because a lot of people view probability and luck differently.
There are casinos that let people know which slot machines have had the most winners to see if more people will try their luck at those luckier machines.
Some people will play slot machines that havent been paying out thinking they will eventually pay out and they will be the winner.
Argh! I truly wish your books were in Kindle or ebook format! I would have bought all three ALREADY! I travel frequently and like to carry books electronically. 😒
coffeezilla lead me here
Sound quality needs improvement upon. Perhaps a clip mic or boom, but it’s muffled. Mic is too far away causing a bassy muffled audio.
okay now the questions is, HOW to apply probability to investing, exactly :)
Who the hell gives this a thumbs down??
Bad aim? 😂
Day traders thumbed down
Unfortunately Taleb indicates fat tails are far fatter than traditionally calculated statistics admit and wipe out completely the norm. One of the best hedge fund mangers in the world aims to be 51% correct at the end of the year. The issue is that probability in statistics is based on past data in that the mean and dispersion are fixed and are not In real-time. Although financial markets have a lot of data , they also have a lot of computers and a lot of people. It’s not rolling a dice. If you get several extreme ,devastating events that should only happen once in 400 years, then naturally, you’re past mean, dispersion measure is irrelevant. In insurance companies things move slower so actuaries have plenty of time to alter their calculations.
So, John Law made his wedge, and indrectly bankrupted France, based on an incomplete, but successful enough during his outright gambling years, understanding of stats application to "Likelihood". Rene Pascal should jave taken heed and not gambled, but then he wouldnt have helped lay down the rules of probabiltity, still he would not have gone all religious and I would not have been forced to read "Penses" at uni, wow gamblers remorse writ large over a lot of well turgid tosh with no open admission that it was his "roulette system" than made him find faith after he was utterly ruined at the tables
Patrick, in this video you constantly confuse probability with uncertainty. Future prices is not the same as repeating an event which has a well defined and predetermined outcomes, like throwing dice.
?
2:38 Not to brag, but I can tell you who is going to win in the Washington DC in 2024😋I'll stake my house on it. (DC votes massively and overwhelmingly democrat because of it's demographics; black and educated, in 2016 4% voted for Trump)
Terrible audio.
*What a sad , apologetic , aggressively reconciliatory repute patch up of probability's weak points and failures. Just admit probability isn't omnidiagnostic and like any other calculational systematic methodology has reasonable limitations. Why simp to mask and misguide ?*