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Misconceptions: Probability Trading vs Arbitrage

I recently responded to a friend who asked me what I felt were the most common misconceptions about trend trading. I answered as follows:

If you really want my opinion, it as follows. People really, really do not understand probability trading. This is perhaps one of the least understood aspects of trading or investing to the newcomer. What the newbie is really expecting is “arbitrage” and risk free arbitrage at that. Trend Following is probability trading – probably you win out over the long term, after some devastating volatility and draw down, which will usually be vastly magnified by the insane leverage usually recommended by the systems sellers.  You assess the probability with back testing but we all know the past is no sure indicator of the future. What used to work may not continue to work.

What most people are really looking for is “arbitrage” and risk free arbitrage at that. And they are barking up the wrong tree. Arbitrage IS available in the markets but these days only to HFT scalpers: in 1/10000th of a second they will be able to arb between party (a) offering at a price lower than party (b)’s bid.  And of course they can front run: which is not arbing but sure as hell is high probability stuff; and of course ought to be illegal / is illegal but no one seems to care at the regulators.

That is really what people think they are doing with all their insane technical analysis and opening gap trades and so forth.

My IPO trading (flipping) back in the 90s was a form of arb: bulge bracket operators were offering stock deliberately cheap in the tech boom days. I never had a losing month.

Sports betting arb is still possible in small size.

Arb is about locking in profits days after day after day.

People should be absolutely sure they understand this. Arbing is provably profitable day by day. With probability trading such as TF you never really know whether it will work out in the long term or not. Some people even deny that trends even exist.

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