Why favorable R:R?

Discussion in 'Risk Management' started by frostengine, Dec 8, 2008.

  1. There is no such thing as the "expectancy of the probability". There is no such thing as "expectancy" formally defined either.

    Calling expectancy the expected gain of a trading system was not a good choice of a term made by Tharp.

    He obviously meant the expected gain of a trade, which is the probability-weighted sum of the possible values of the random variable "trade P/L", when the sample size approaches infinity.

    The expected gain. or expectancy, is the "edge" of a trading system, i.e. the amount it is expected to win per trade on the average as the sample size becomes very large.

    The average win is the odds of the trading system, i.e. the amount made when a trade is a winner on the average.

    Expectancy/average win = optimal bet size (approximately)

    See: http://www.tradingpatterns.com/Kelly.pdf
     
    #51     Dec 14, 2008
  2. Specterx

    Specterx

    I believe this is what you're talking about:

    http://www.elitetrader.com/vb/showthread.php?s=&postid=2215951#post2215951

    The "monkey" who takes trades randomly should make a profit (loss) of zero, minus commissions, minus slippage, minus the spread on each leg of the trade (2 ticks per ES roundturn).

    The probability of getting stopped in the above scenario is a bit more than 50%, due to the spread and nature of limit vs. market orders. The effect is significant at low values of X but you get closer to 50% as X gets larger.

    I'm at a loss as to how to take this further, though. Ultimately your entries and/or exits need to be non-random in order to achieve positive expectancy.
     
    #52     Dec 14, 2008
  3. mynd66

    mynd66

    thanks intradaybill, I actually just bought myself a little early xmas gift and picked up that book. Sometimes I feel its hard enough just to find worth while information let alone implementing it. Recomendations are a little more reassuring than judging by the cover. Thanks again. -Ray
     
    #53     Dec 14, 2008
  4. True only at the limit, i.e. for a sufficiently large number of trades.

    In the short term, nothing can be said about the monkey performance.

    Zero profit equals zero expectancy only at the limit.
     
    #54     Dec 14, 2008
  5. You are welcome. The first 6 chapters of the book contain valuable and down to earth information for both discretionary and systematic traders. If you are into backtesting you will find the section about pitfalls in chapter 6 very interesting.
     
    #55     Dec 14, 2008
  6. Cesko

    Cesko

    I'm at a loss as to how to take this further, though. Ultimately your entries and/or exits need to be non-random in order to achieve positive expectancy.

    Tape reading and following rules like an idiot. That's where the thinking should stop.
     
    #56     Dec 19, 2008
  7. ronblack

    ronblack

    There are many hyped-up authors publishing trading books but many of them have never actually traded a single share or futures contarct. It is sad that legitimate publishing houses even consider authors without a trading record to back up at least some of their claims.

    Michael Harris and a few others are rare exceptions to the rule but they are not hyped-up because they tell the truth and people do not like to listen to it, especially the counterparties to retail trades.

    Ron
     
    #57     Dec 27, 2008
  8. nkhoi

    nkhoi

    you are correct, further thoughts;
    "People use so many useless and irrational practices in their trading. They pick stops and targets based on their entry points. They try to hold on for break-even when they are underwater. This is all trade-centric thinking! It’s thinking relative to your trade, which is insignificant. Your entry price may be a precious snowflake to you, but the market doesn’t know or care. Logically you all know this, and yet when a trade is on, most of you focus entirely on the market relative to your entry price. Give that up! You are dancing with the market. And when you dance with the market, it always leads. "
    Richard -movethemarkets
     
    #58     Dec 27, 2008
  9. Yes let expectancy drive stop placement. Not the other way around.
     
    #59     Dec 27, 2008
  10. I think stops have to be based on entry points at least to extent to what the trader wants to risk.
     
    #60     Dec 27, 2008