Probability Stacking- A Missing Key

Probability Stacking is a term I have coined that relates to the collecting of layers of probability in the design of trading systems for the financial markets. For me, as a concept, a framework and a practice, it has come to represent a missing key.

If you were to design a trading system for the financial markets, where would you start? Where would you end? Generally speaking, there are about seven categories of tools or data sources we can use-

  1. Fundamental– company or macro economic data.
  2. Technical– chart related data and patterns.
  3. Sentiment– including volume related data and other broader buyer/ seller data types.
  4. Momentum– looking at raw numbers usually of price or price related data.
  5. Seasonal– using seasonal or statistical patterns for specific markets.
  6. Price Patterns– pure price action patterns or data.
  7. Correlates– correlated (positively or negatively) markets or data sources.

In trading systems research and design, it is very much the case that less is more. A robust system will usually involve three to five data sources. Their combinations will be varied and tested to find a robust system’s edge.

In all of these movements, probability is the core idea. Markets are imprecise. Humans are imprecise. Systems are imprecise. Systems are usually a mix of mechanical and discretionary rules or guidelines. I call these Hybrid Systems. They have the necessary flexibility and adaptability to work in the long term. Adaptability breeds robustness.

Robustness is a consequence of probability stacking. Too much of one or the other, then the trading system becomes skewed. This is often seen in technical or fundamental heavy systems. These systems usually fall foul of negative elements such as, Curve Fitting or Cognitive Biases.

Another important thing to note is when selecting data sources, ensure they are different and not correlated, positively or negatively. This gives us greater weight when we stack the probabilities. For example, a Price Pattern plus a Seasonal Pattern strengthen each other, and give us a greater overall probability.

Probability Stacking (P) for a systems Edge (E) can be expressed as a simple formula-

E = P1 x P2 x P3 …P5

Probability Stacking I have found over many years of work, has become a missing key. When we get it right, we have a pathway for long term trading success in any market type. This is not easy work. Probability Stacking gives us a framework to create systems. A meta system. From here we can then build the other elements more easily, particularly the psychological ones, such as a quiet, calm confidence for scaling and ease of application.

“Focus, patience, wise discernment, non-attachment- the skills you acquire in meditation and the skills you need to thrive in trading are one and the same.”- Yvan Byeajee

By Lee Spano, Creatness International www.creatness.com