<div align="justify"><span style=";font-family:trebuchet ms;font-size:85%;" >Edge: This is one of the most basic concepts in trading, yet it seems like most starting out pay very little attention to this, so i will make an attempt to define it. When it comes to trading, an edge is defined as something that will put the odds in your favor. Quantitatively or mathematically speaking, having an edge would mean that whichever methodologies that you are using to enter and exit positions yield a positive mathematical expectancy. To simplify it further, this would mean that during the trading session you were trading with a higher probability of being net positive than being net negative. The most common examples of negative expectancy games are the games played in casinos. They are presented with the odds in the favor of the house, meaning the house has the positive expectancy and you, the gambler, have the negative expectancy. The only reason that one might win in a negative expectancy game is because probabilities are distributed randomly. Simply put, people win in casinos for the same reason why you might get 4 heads in a row instead of heads-tails-heads-tails while flipping a coin, though the chances of it being heads or tails is 50/50. Formula for Expectancy: <center>Expectancy = [(((WIN: LOSS ratio) + 1) x (Percent Profitable)) - 1]</center> So for example if your average win is $600 and your average loss is $200 then you have a WIN: LOSS ratio of 3, and if on average out of a sample of 100 trades 40 were winners then your percent profitable would be 40% and your expectancy would be .60. In this case we would be trading with a positive expectancy. <center>Expectancy = [(((3) + 1) x (.40)) -1] = .60</center> The key is to have a positive expectancy when you trade. Of course, by now you may notice that to even determine if you are trading with an edge or not, you need a good sized sample of trades, and you have to be applying your methodology without any deviations from the rules throughout the entire sample for this to mean anything. If you were inconsistent in your methodology or approach, then it would be very difficult to come to any conclusions by analyzing your results because they will be random at best. Of course in this case you will not know if what you are doing (your methodology) is actually putting the odds in your favor or not. This is why many starting out fool themselves with "discretionary" trading, but that is an entirely different discussion. In a world where market returns are normally distributed the equity curves of numerous expectancies would look similar to this: </span></div> <center><img src="http://img134.imageshack.us/img134/8930/expectancy1zf1.gif" /> </center> <div align="justify"><span style=";font-family:trebuchet ms;font-size:85%;" >But returns are not normally distributed therefore a positive expectancy equity curve in reality might look like something like this:</span></div> <center><img src="http://img134.imageshack.us/img134/8669/expectancy2nr2.gif" /> </center><div style="text-align: justify;"><span style=";font-family:trebuchet ms;font-size:85%;" >The expectancy of an edge can vary anywhere from -1 to 1 and beyond. However, for you to be profitable, your expectancy must be positive, and of course the higher above zero the better. A realistic expectancy number to shoot for, at least in my opinion, would be .50.</span> </div><p><span style=";font-family:trebuchet ms;font-size:85%;" > So there you have it. That is my two cents on what an edge is. </span></p><p align="right"><span style=";font-family:trebuchet ms;font-size:85%;" >-<strong><em>shanoballs</em></strong></span></p>
Also simplified as: (Average win size * %tage wins) - (Average loss size * %tage loss) Money management and risk management have to do with avg win and avg loss size, whereas %tage wins and %tage loss have to do with Edge and market conditions. Note that positive expectancy is NOT an edge, but is the result of many things coming together, part of which is an edge. Also note the distinguishing of Edge and market conditions. Great way to tie in everything.
Add-in: Notice how u can still have positive expectacy - ie make money, even though you may not have an edge, if market conditions prove favorable. This is why it is important to perform proper 'edge-tests' to confirm that one does have an edge (proving statistical significance of edge vs random). Interesting because it brings into the debate if strategy or tactics should be weighted or given emphasis on - strategy meaning correctly defining the market conditions to employ the proper system, be it trend following, reversal, etc. or tactical meaning finding edges and exploiting them. Acrary in the end discovered that strategy played a much larger part b/c he spent most of his later years finding and exploiting edges.
Yes, you are "missing something". It is the same "something" that I pointed out a while back in the context of the "ES" journal (Buy1Sell2). Unfortunately neither you nor B1S2 "got it" then and apparently you still do not get the point. The comment about proper testing and evaluation of a system to determine an edge is THE POINT. Without that, you certainly can make money, and you may THINK you have the ability to make more than you lose, UNTIL mysteriously it all closes down on you. THAT is the difference between having an edge, and simply being the beneficiary of random good luck. When one runs out (luck) you don't get any advance warning. When an edge stops working, IF you know how to test, you DO get an advance warning. Now I am guessing you won't like what you have read. You were resistant to it back then, and B1S2 decided to ask me not to post. No problem. But if you ask as you did. I have to say. Its only a matter of time till you get a real demo of that underlying principle. When that happens, will your "ability" have changed? Probably not. It will probably be just an example of "no edge" at work. Steve
Excuse me, but even if you have a proven statistical edge, your properly tested system can start losing money anytime. Also I think to compare casinos' edge to a trader's edge is misleading because casino games are based on a very restricted rule set. Market are changing continuously. So even if you think you've found a statistical edge, it may disappear at any time. GS
Thus emphasizing the necessity of proper edge testing over time. Once your edge starts to degrade, it is time to move on to a new one. This is the same for any type of system - even an edgeless trend following system will make money in a trending market - think the late 90's bull market - but in a trendless range-bound market, it will suffer. I would rather trade with an edge and properly test the significance of it, having advance warning if it starts to weaken, than to rely purely on market conditions. Think about it. If you are trading without an edge, how will you know when your system is suffering? A drawdown would be a rude awakening.
You are excused. You are correct. Even a properly tested system MAY lose money, and it can start to lose money at any time. IF you have understood my comment, you will remember that there is a way TO TEST, so that you know if your edge is degrading or disappearing. IF you didnt have an edge to begin with, because for instance you believed that YOUR edge was the ability to make money, then IF and WHEN you start to lose money, you will have no idea why... I hope this makes it clearer. IN a casino, periodically they will lose more than they take in on specific games. They watch this process carefully because they know what the limits of their losses should be if the game is being run correctly. IF the losses exceed what the math projects as an upper limit, they KNOW that someone is doing something wrong and it is affecting the profits. Thanks Steve
tireq & steve46, Knowing that I have a system with statistical edge or not, made no difference to me. I hope you are not both speaking theoretically, but formerly I used to think like you that "if you have a statistical edge you know why you're starting to lose money" but, sadly, after having tried several systems live, some of them statistically tested and some not, I scientifically concluded that the result is pretty much the same (i.e., NO statistical difference): when they stop working you start to lose money GS
In general this means that you don't know what you are doing. Now at this point, I have to stop. I don't know you. You don't know me. I can be right or wrong. We don't know. What I do know is that most people posting here do not have the math skills necessary, not only to test (that isn't the difficult part) but to evaluate the results accurately.
Okay then I have had enough. Forex is a scam. Its that simple. You have one post to your credit and SURPRISE it is about Forex. You guys can take it from here. It doesn't mean that much to me to argue with scam artists. I'd rather sleep. Good night Steve