50/50 ?

This idea that you have a 50/50 chance of being right on a trade is bull. A lot of newer traders believe this and wonder why half of their trades dont go their way. It may be true that there is a 50/50 chance that it will go up or down after you enter but the path it takes determines your fate. I think you have to think of your trade as a three part package and state the equation as: does the trade have a 50/50 chance of hitting my target before it hits my stoploss? This is an entirely different proposition. I have heard a lot of people claim that you can enter randomly and make money by proper money management. If this is true then there must be an optimum stop loss to target ratio. Does anybody know of any research along this line?

 

I avoid entering trades randomly (grin). But think I can show you that the better trade management you have, the better chance you have of making it, even if entering randomly.

I believe that the most important statistic for a trader is the net gain / net loss ratio. Lets call it R. Knowing R, you can calculate the minimum success percentage (MSP) in order to break even. To find this percentage, use the formula:

MSP = 1 / (R + 1)

Now, consider the following examples:

R MSP
0.25 80% (if you lose 4 times what you win, you have to be right 80% of the time )
0.50 67%
0.75 57%
1.0 50%
1.25 44%
1.50 40%
1.75 36%
2.00 33%
2.25 31%
2.50 29%
7.00 14% (if you make 7 times what you lose, you need to be right 14% of the time ).

You can see that by maximizing R, you minimize the number of times that you need to be correct. The only way to maximize R is: “CUT YOUR LOSSES AND LET YOUR WINNERS RUN”.

Regarding stops: You can achieve any value of R using any combination of stop and targets so that STOP = TARGET / R.
If your system works at least MSP times with that given STOP and TARGET combination, then you’ll at least break even.

 

If you keep your profit target and stop loss the same, then, yeah, a random buy/sell would have a 50/50 shot of reaching either within the time frame you've specified.

Of course you need to keep the target/stop loss within what is reasonable to occur in your given timeframe. For example, if you set the target/loss at $5, but your timeframe is half an hour, it's not really going to happen..(unless we rewind a couple of years)

(of course, you can't make money trading like this,..you'll still need some 'skill' to get either the percentage of winners up, or the size of winners compared to losers up (way up!)... )

 

From what I understand, you are asking if there is any research predicated on some common entry that will determine odds of market hitting ur target prior to your stop loss...This sounds pretty similar to the study done by either Murray Ruggiero or John Sweeney and the concept of using statistical analysis to find the optimum amount of drawdown to accept prior to the odds of a positive fav excursion being eliminated...MFE vs MAE

This concept has alot of merit, imo...For instance, if you really had good hard stats in front of you that told u if entering on x with y profit target and z stop how often would the trade return to y after the z was penetrated...A few books have the code for either Excel or any of the other popular software testing platforms...

 

i suspect the problem with 50/50 relates to it being a positive or negative move from the entry point, but a half point rise in the s&p and then a 1 pt drop, and noise around the entry point, would achieve a 50/50 ratio, but only make the broker rich as u kept getting chopped

 

yep, that is true...The "noise" element or range in the indicies is constantly changing, even during the day itself...There is no reasonable means of testing it on that short of a time frame, its just too damn random...But going out several handles things probably become smoother

 

easyrider,

This is a malformed question, and cannot really be answered unless you give the ONLY thing that matters: How many trials of this 50/50 setup can we run? If you say, oh, 100000 - then almost with certainty, the question that you posed is tautologous.

If something is 50/50 - no amount of anything (money management, stop loss, etc) over the long term will turn that into positve expentancy over many trials.

50/50 means 50/50 - it is atomic.

nitro

 

lcamargo,

Thanks for this post - rarely do I see stuff of real substance here on ET. This one qualifies...

nitro

 

nitro,

Thank you for you comments. I find that aproaching trading as a statistical exercise helps me keep my emotions in check and to practice good money management.

You may find the following interesting:

tMn(RT+T-1)=N

Where:
t is your profit target expressed as a percentage of M.
M is the money you are risking per trade.
n is the number of trades.
R is the net gain / net loss ratio as in my previous post.
T is your winning trades / total trades.

N is the net gain or loss.

Assuming that you can keep R and T constant, you can find the number of trades required to double (or lose) M using:

n = 2 / t (RT + T – 1)

and the EQUIVALENT return of investment per trade will converge to:

EROI = t(RT + T – 1)

I find the above very interesting because it proves that there are many systems that work, as long as you have the discipline to follow them. For example, consider the following systems:

R=2.50 T=0.50 t=0.05 doubles M in 53 trades EROI = 3.75%
R=2.67 T=0.58 t=0.10 doubles M in 17 trades EROI = 11.29%
R=1.25 T=0.70 t=0.05 doubles M in 70 trades EROI = 2.88%

And the broker’s favorite :

R=1.0 T=0.50 t=0.05 doubles M in an infinitum number of trades with a EROI = 0.00%