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# THE PROFITABLE STRATEGY

THE PROFITABLE STRATEGY

Imagine stock market as a horse racing bet. It has thousands of horse to bet on, each with different payout and different duration. Investment can be profitable with a strategy. Here is the criteria for such strategy.

LOSS/REWARD RATIO

In relative to the losses suffer, could a profitable gain be sufficient to offset such cost? It is inevitable that humans make mistake and create losses, these are our cost. Only if we make more gains than losses that we will have profit. Let's say a strings of trade net you losses is \$50, but the gains is \$150, you will net a profit of \$100. Repeat the sequence and you will be able to earn a fortunate.

KELLY CRITERION/PROBABILITY

This dictates you to take bet on the probability on winning. Let's say your probability of winning is 60%, the payout is 1:1, your bet should be 20% of your portfolio. Most people calculate on their winning and its size. If we see it reverse, it would be 40% of losing. What happens is when you are able to minimise your losses to 20% according to Pareto Ratio, you should be able to take huge bets in your portfolio while not losing your shirt. Hit the home runs. In a scenario where only 20% of chance losing while getting an outsized return in payout 3:1, a 66% portfolio allocation would easily cover your losses by having an net Expected value of EV Winnning (\$0.8) - EV losing (\$0.2) = Net EV \$0.6 x 66% x \$3= \$1.18. Even better if you are able to minimise the losses to a certain extant. Let's said losing the bet only lost 30% of your invested amount, EV winning (0.8) - EV losing (\$0.2 * 30%) = Net EV \$0.74 x 66% x \$3 = \$1.46, for each \$1 you can expect \$1.46 return.

DURATION/FREQUENCY

Long term investment takes 2-5 years to yield the required return; High Frequency trading required millisecond; Arbitrage takes weeks; Option and day traders do it in days. Each approaches require time and frequency. There are inclination/preferences for each people according to their abilities/personalities to do what seems to be optimal. A high frequency trading may yield little, but the frequency (in thousands per day) and duration (millisecond) can accumulate wealth quickly. Long term investment have long duration, and its frequency is low (only certain companies provide outsized return), but its size is sufficient to justify the strategy.

NON MUTUALLY EXCLUSIVE

Assuming betting on horse A prohibits you from betting horse B, when horse B wins you lost. In stock market, investing company A doesn't prohibits you from investing company B. In trading, the same applies, when you trade company A, company B share price does not affected. Which is why some portfolio size when reached certain proportion can't undertake certain strategy without jeopardising it underlying, which is a mutually exclusive scenario. Let's said Warren Buffett decides to invest in Apple, it had to make huge bet to justify its return to its portfolio, and when such huge bet are made, the share price went up, the portfolio cost went up and its overall return conversely went down. This is a mutually exclusive scenario that might negated the initial assumption of expected return.