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I know that I’m wrong here but why am I wrong?

So, contracts for difference on S&P 500:

The spread’s less than a point. We also know that at that level of a point then the price in the market is a random walk.

It’s also possible to have gearing – up to 200x in some places.

I am told, told, that it’s possible to set stop losses.

So, £10 bet. Bull. With 100x gearing. Random chance, 50/50, that the first point is win or lose. So too second point, from that new starting point and on.

OK, so, if first point is bear then I’m sold out of my position because of the stop loss. Maximum loss, £10.

First point is bull, covered the spread. Second point is bull I’m £1000 up. Second point is bear I’m level. Third point is bull, I’m £2,000 up. Second and third points are bear I’m sold out. And so on.

My maximum loss is £10 and my gains, theoretically, unlimited. On a 50/50 bet at each point.

Now, clearly, this doesn’t actually work. But why doesn’t it?

Can I not put a stop loss on at the current market price? That would kill the idea real quick. Can I not put a stop loss on at all?

I seem to have a £10 loss at 50% and a 25% chance of a £1000 up, 12.5% of £2,000 up and so on. Which would be entirely insane if that really was the offer. So, it isn’t. But why isn’t it?

9 thoughts on “I know that I’m wrong here but why am I wrong?”

  1. Bloke in the Fourth Reich

    It’s very late, and it’s been a long day, and I am now medicating the long day away, but it sounds very gambler’s fallacy.

    First reason it doesn’t work: this is the stuff that various Flying Ferraris and Masters of the Universe trade pro all day long with the backing of billions of client money to squeeze out a few pennies. They are better than you at it. That’s the “house number” on the roulette wheel.

    Second reason it doesn’t work: your stop-loss will not in practice activate at exactly the price you want, and that stop-loss (or forward order) will be at, on average, a slightly disadvantageous price to you. For whatever reason, being a real reason, or a second green number on that roulette wheel because your trading platform have their thumb on the scales in some imperceptible manner. On small highly leveraged margins this matters a lot more than on your 3 remaining Tesla shares.

    Does this sound plausible to the assembled banking wonks of this parish?

  2. Bloke in the Fourth Reich

    Alternatively, and I really wouldn’t rule this out, this is exactly how the teetering entire global financial system is currently being held in some kind of order, and your publishing the fact is going to result in Armageddon tomorrow.

  3. I’m sure this was examined in a book about numbers that was recommended here, but I’ve got in storage so can’t check. Something like “Misunderstanding Probability”.

  4. The gearing works both ways, so either you lose £1000 on a downward move or your chance of a downward move is actually 100/101.

  5. Surely its what Clovis says above? The gearing works both ways, your stop loss doesn’t just lose you the cash stake. If the first movement is down by one point, which triggers the stop loss, with 100x gearing you just lost £1000.

    I think you’re muddling up it up with buying options, whereby if your ‘bet’ fails the most you lose is the what the option cost you in the first place.

  6. Bloke who works in markets

    Clovis and Jim have the answer. The stop loss does not guarantee you a price, it just guarantees that you get stopped out. So the p+l is symmetric – there’s no free option here.

  7. You also need to worry about gapping. If the price takes a sudden downward turn it can jump right over your stop-loss. Where it lands is where, usually, your order is filled and your losses end. The jump can be an arbitrry number of pips so your losses are effectively unlimited. This is one of the main reasons highly leveraged positions are very dangerous.

  8. Is it actually a random walk? Mostly shares have what I would call “jitter” : that is rapid movement around an accepted value, that moves only quite slowly. Each time there is a largish fluctuation upwards, then the next shift is much more likely to be down than up.

    Shares clearly don’t wander entirely at random. The guys who make money off imbalances see to that.

  9. Yes you are wrong. The same magnitude of change that wipes you out if it’s negative, only makes you £10 if it is positive. Gearing works equally both ways.

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