| Imagine a simple coin-tossing game where you | | | | that we have 'curve-fitted' our system to |
| win whatever you stake if heads comes up, lose | | | | historical results that are unlikely to continue into |
| what you stake if tails comes up, and you are | | | | the future. |
| charged 1% of your stake each turn to play. Can | | | | It is also important to note that for some types |
| you win money at this game? If you are familiar | | | | of trading (i.e. long-term trend following strategies) |
| with the concept of expectancy, then you will | | | | it may not be possible to have a win percentage |
| probably answer 'No' since over many turns the | | | | that is greater than 50% (and it may be much |
| amount won will be equal to the amount lost | | | | lower) and that is where the second aspect of |
| (assuming the coin is a fair one) and after | | | | improving your system comes into play: the |
| factoring in the 1% cost of playing you will lose | | | | average size of winners versus losers. |
| money overall. | | | | Increasing the size of the payout so that the |
| In fact, there is a way to win this game, and that | | | | winners win more on average than the losers lose |
| is to understand that the longer you play, the | | | | depends on the way you handle your stops. |
| more you will lose, so the optimum strategy is to | | | | Having large winners in relation to losers can make |
| bet everything you have on just one toss of the | | | | up for a low win percentage, and mean that you |
| coin just like Ashley Revell did when he sold | | | | will still make money playing the game. One |
| everything he owned, took the $135,300 to Las | | | | method is to have a trailing stop that moves up |
| Vegas, and bet it all on 'Red' on one spin of the | | | | as a trade becomes a winner. If you have fixed |
| roulette wheel. Mr. Revell was fortunate and he | | | | stops for losing trades that limit losses, but trailing |
| won, but I am not recommending that you bet | | | | stops for winning ones that allow winners to |
| everything you have on one trade! | | | | grow, then you are increasing your chances of |
| Obviously risking everything on one trade is not a | | | | your average winner being larger than your |
| useful strategy since we want a game we can | | | | average loser. Generally it is better to be strict on |
| play for long periods of time to generate a | | | | losers by having tighter stops that keep losses to |
| consistent income. So how can we change the | | | | a minimum and generous with winners by having |
| game so that we can win? There are three | | | | stops that allow profits to grow. In any case you |
| aspects to the game which can be adjusted to | | | | want to make losers small and winners large, so |
| increase our chances of winning consistently: | | | | never add to a losing trade - that would be doing |
| - We can tip the chance of a winner in our favor | | | | the opposite of what you want to achieve. |
| from 50/50 | | | | Lastly, reducing the costs of trading is probably |
| - We can increase the size of the payout from 1:1 | | | | the simplest change you can make, and can mean |
| - We can reduce the cost of playing the game | | | | the difference between winning and losing overall - |
| Tipping the chances of a winner is not possible in | | | | especially for systems that have lower |
| a fair coin toss game, but it is possible in trading. | | | | expectancy. There are many online brokers now |
| There are two ways to approach this: identify | | | | that charge 1c per share for equity trades (and |
| conditions that are more favorable to your | | | | comparably low fees for other instrument types) |
| winners and include them in your system | | | | and there is no reason why you should be paying |
| definition, or identify circumstances where a loser | | | | more than this if you are trading electronically. |
| is more likely, and skip those trades. For example, | | | | Every trader should do whatever they can to |
| if you notice that most of your winners are | | | | maximize the expectancy of their trading system |
| entered on days where the overall market has | | | | or method by considering each of the 3 aspects |
| moved in the same direction as your trade, then | | | | just described. If we do some, or all, of these |
| only enter trades when the overall market is | | | | things then the amount we win now becomes a |
| moving in the correct direction. This means that | | | | factor of how much we stake, and how often |
| your trade is in the same direction of the overall | | | | we play because we have created a true 'edge' |
| market, rather than against it. | | | | where we know that the system we are trading |
| Another example might be that trades that are | | | | should make money (if traded accurately). |
| entered just before major news announcements, | | | | Calculating the expectancy of your trading |
| like earnings calls, often get stopped out as losers | | | | system or method tells you whether you are |
| due to increased volatility, so you should skip | | | | playing a game you can win, and is a very |
| those trades. | | | | important piece of information that every trader |
| There may be many patterns of winners and | | | | should know before they risk real money. |
| losers that you can identify for your own | | | | If the game is rigged against you because your |
| systems and careful study of past trades is | | | | trading methods lose money regardless of how |
| definitely worthwhile. Note that we do not want | | | | accurately you implement them, how can you |
| to increase our win percentage too significantly | | | | ever be a successful trader? |
| (i.e. to greater than 60%) since this would indicate | | | | |