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