To be honest I have fast read this thread, but I can see that a great amount of thought and detail have been committed by the Posters. It is indeed a thought provoking subject. Now, I am more inclined to let the numbers fall as they may. One ratio that does crop up daily is the number of entry attempts compared to the number of pulled stops. But even this fades in time. regards f9
For a derivation of the formula that relates the win/success rate to R:R and profit factor, as well as, a good discussion relating to trading different timeframes, read this paper by Michael Harris: http://www.tradingpatterns.com/profitability.pdf For the derivation and use of Expectancy in optimal position sizing read the next paper, also by Michael Harris, http://www.tradingpatterns.com/Kelly.pdf Both papers are excellent IMO and provide a solid foundation of the subject. Note that in the first paper the success rate is called profitability P. Ron
"In your example above, even if the trader does win 75% of the time, he will lose money or at best have lackluster profits due to a too big stop loss size, slippage, commish, etc." That makes zero sense. So basically I came up with a imaginary success rate and you shoot it down by saying stop loss, commissions blah blah. Expectancy is basically the belief in probability. You trade momentum because there is a good probability price will keep going in the direction of momentum. You know there are more ways of trading than momentum though right? There are other ways of trading that don't relate towards jumping in momentum after 20 or 30 minutes which depend much more on expectancy and probabilities. Also you seem to be the one with the small angry mind- "Or said trader will delude themselves by looking at yesterday's charts and thinking they have a robust methodology expectation when in forward realtime, they really don't, because they can't recognize said setup as it is happening, only later when the market is closed. Or they falsely pull the trigger when the setup is not there. Or don't wait for confirmation. Or any one of many ways they wreck their own plan." Why do you have a such a negative image of a trader with a system or strategy that yields evidence and high probabilities of winning trades? Besides all the bitching the only statements you made were negative statements on the foundation of successful trading. What does that say about yourself?
RFT, Thought about this some more... understand that the risk (i.e. initial stop) definitely impacts probabilities but what would the reward side - why is that not a factor? (i.e. for a given risk, trying to get a higher reward leads to lower win ratio) Or are you saying something else? Look forward to getting your perspectives.
just a thought experiment... say a hundred people each starting with the same size account began trading only limited on their holding period and size. Every trade long or short was based on nothing and was totally random. If this was conducted everyday for a year the ending balances would be random too. Would it be fair to say that each had a 50% chance to be profitable (excluding commisions/slippage/spread)? Now consider the same senario except each applied the same basic money managment technique only to exit positions. Would it then be safe to say that the overall returns would be a bit higher after a year? I am just having a hard time when people say that in certain situations or when certain things are done you increase or decrease the probability or likleyness of the outcome. If you start with a 50/50 chance than it doesn't take much for everyone to be more likley to win than lose using simple techniques. Why is this not the case, why still do most fail? Can money management alone make a trader anymore profitable? It seems that any common knowlege in the markets whether it be technical, fundamental, MM will be a self fufilling prophecy. Anything in general that should increase the probability of being profitable would seem to either do the opposite or nothing. Everyone can't do the same thing. Doesn't it all come down to having an edge, something original?
Money managment is a vague term. You should be using Risk Management instead. Risk Managment RULES OUT random decisions so your experiment is invalid. Proper risk managment involves, amongst other things, estimation of trading probabilities with the objective of maintaining an edge. Edge is also a relative thing. If there is a steady influx in the market of recreational traders, even a simple moving average crossover can provide an edge. Ron provided a couple of links to the website of Michael Harris, whose work is quantitative and down to earth. I suggest you look for a copy of his book Profitability and Systematic Trading in your local library and read carefully chapters 1 through 5. On page 23 he writes: "The accumulated profits of rational and skilled traders in zero-sum game markets depend on a constant influx of unskilled and recreational traders who are destined to lose, and whose losses become the profits of the winners. Few of the unskilled traders will eventually survive the zero-sum game and turn profitable at the expense of other traders. ...The only chances an individual trader or manager of a small fund who base their decisions on the analysis of price and volume have depend on how innovative and disciplined they are in determining the timing of entry and exit points and managing risk (EDGE). Profitability combined with risk AND money managment is the KEY to beating the odds of the zero-sum game". (Caps added by me) He said it all... http://www.wiley.com/WileyCDA/WileyTitle/productCd-047022908X.html
you guys are doing it all wrong. you have to look at the expectancy of the probability, not the probability of the expectancy or you should just remove probability or expectancy and go with one of these two. Lets say you have a setup that determines reversal, one happens at 9:30 and one at 11:00. obviously the probability of the expectancy of the first time at which the setup occurs will be much less. That's why It's much easier for discretionary traders to make money then mechanical traders. Discretionary ones look at the probability of the expectancy on every trade, while mechanical ones do it on a large number of trades and the average of those. But in the real market, every trade is unique. The set-up might be the same, but the outcome/probability/expectancy won't be exactly the same, but favorable nonetheless.
Perhaps Before agreeing/disagreeing, let's make sure we are talking about the same things. I've defined my understanding of expectancy and probability earlier (essentially van tharps view of the world). Could you please define yours so we can then meaningfully debate your assertion. Thanks.
OP, I have not cranked huge amounts of data to answer your question as you posed it. IMO, the reason all the CD, seminars, books, and so on, implore the reader to have a high R:R is because most traders do go broke taking profits. That's right, it is easy to go broke taking profits if they are smaller than losses and after adding commissions and slippage, a negative expectancy is at the core of trading for all save a gifted few. This is even more true for day traders generating many transactions. It's bizarre how many traders know this fact and yet they still can't contol themselves. Dollar or dollar, trade for trade, a successful swing trader will beat his intraday comrade time and again and have a lot less stress doing it. So, I ask myself why I haven't become a swinger rather than an intradayer: The honest answer is I sleep better at night knowing I won't wake up and see a black swan on the screen.