Why favorable R:R?

Mr J yes I actually read your text. But you failed to read mine….

This is the definition of statistics from one of many web sites “… statistics is a branch of mathematics for collecting and analyzing data to draw conclusions and make predictions…” That sounds familiar. So when you draw conclusions and make predictions you are defining probability. Just like expectancy!

Expectancy like Reward to Risk is derived from raw data so by definition they are both statistics used to draw conclusions, make predictions or define probability. You have stated over and over again expectancy is not a statistic. It is a statistic and no amount of discussion will change that. Expectancy is derived from raw data and cannot under any means be anything else but mathematical metadata (mathematical metadata is a statistical definition from Harvards web site).

Statistical significance has every thing to do with this post. Traders toss statistical measures like expectancy and position sizing about ET like manure trying to grow or push their method of trading. Traders like you Mr J expect traders like me to digest your brand of statistics as gospel. For example you stated empirically and with out any retraction:

If you practice sensbile capital management, the risk to reward is irrelevent. All that matters is that the trade is +ev and appropriately sized.

You left no room for discussion in your posts. Mr J I dare you to detail some real live trading examples of how EV can be used by traders rather than make your useless glittering generalities.

 

Mr J if you Google “Trading expectancy” you get a variety of answers for expectancy under the many entries. Here are some that are I found in the first 5 pages. Which is correct and how do you use it with a strategy?

First extract of Expectancy ratio from the web:

At this point we can combine these two numbers to create an expectancy ratio. This is a simple process of multiplying the reward to risk ratio (5) by the percentage of winning trades (28%), and subtracting the percentage of losing trades (72%), which is calculated like this:

(Reward to Risk ratio x win ratio) - Loss ratio = Expectancy Ratio

(5*28%) – (72%) = .68

Superficially, this means that on average you expect this strategy's trades to return .68 times the size of your losers. This is important for two reasons: First, it may seem obvious, but you know right away that you have a positive return. ….

Second extract of Expectancy ratio from the web:

Expectancy is simply the product of your profit percentage per win and your win rate minus the product of your loss percentage per loss and your loss rate. For example:
Win percentage 6%
Win rate 60%
Loss percentage 4%
Loss rate 40%.
The expectancy is 2.0% per trade, or (6% x 60%) - (4% x 40%).
That means, on an average trade, 2% of the money traded is yours to keep. That's better odds than a casino gets on blackjack. Now, that may not sound like a lot of money. If your average trade is $10,000 - 2% is $200 profit per trade. If you have 300 trades per year, then you have a $60,000 profit per year with an average trade of only $10,000. This does not even include the profits if you compounded the average trade.

Here's another example: we could use a 20% stop loss and a 5% profit target and come out with the same exact 2% expectancy as long as my win rate is high enough! An 88% win rate in this example would yield 2.0%, the result of (5% x 88%) - (20% x 12%)…

Third extract of expectancy ratio from the web:

In simple terms, expectancy is the average amount you can expect to win (or lose) per dollar at risk. Here's the formula for expectancy:
Expectancy = (Probability of Win * Average Win) - (Probability of Loss * Average Loss)
As an example let's say that a trader has a system that produces winning trades 30% of the time. That trader's average winning trade nets 10% while losing trades lose 4%. So if he were trading $10,000 positions his expectancy would be:
(0.3 * $1,000) - (0.7 * $300) = $90
So even though that system produces losing trades 70% of the time the expectancy is still positive and thus the trader can make money over time. You can also see how you could have a system that produces winning trades the majority of the time but would have a negative expectancy if the average loss was larger than the average win:
(0.6 * $400) - (0.4 * $650) = -$20
In fact, you could come up with any number of scenarios that would give you a positive, or negative, expectancy…..

 

Rabbit, I have no idea what your last post has to do with your point, or mine. You're just giving examples of expectation, they're not proving anything. You're not arguing with my point, but nitpicking. You don't even realise you're so far off track.

"Traders toss statistical measures like expectancy and position sizing about ET like manure trying to grow or push their method of trading. Traders like you Mr J"

I'm not pushing any type of trading at all. In fact, I actually said that there are many trading strategies with various average R:R ratios, and that profitable trades do not soley rely on R:R. Yes, it's part of the equation, but it just isn't correct to look at R:R and use it to state whether or not a trade is profitable. There are other factors, so focusing on R:R is irrelevant.

Traders like me? The statement you quoted was suggesting that what is needed are good trades that are appropriately sized (in terms of bankroll). Do you seriously disagree with that?

"You left no room for discussion in your posts. Mr J I dare you to detail some real live trading examples of how EV can be used by traders"

You're just arguing something that has nothing to do with my point. I still can't understand what you're trying to suggest, as it's lost amongst all of the irrelevant statements and nitpicking. It does sound like you're trying to suggest that ev is irrelevant, but you're not making it clear. If you are suggesting ev is not important, well there's no point in debating it any further.

As for examples of how to use EV, I never stated it was a value we could use for trades. We don't know the true ev of a trade, so how can we use it? My point was as simple as all that matters is that a trade is profitable. I.e. just make good trades and success will likely follow. Obviously that's a very simplistic statement, but that is precisely what I intended.

 

I have no idea where he fiinds the time to post all this non-sense. Maybe he is trying to prove something to himself because most traders don't give a sh*t about expectancy and how it is calculated.

This expectancy number changes every time you trade, 10:00 AM it is positive, then if you lose at 10:05 AM it may turn negative, it is not a constant number, even a car mechanic like me knows this.

 

Thank you, Jimbojim for your comment. I agree completely. By the way I have the utmost respect for car mechanics since I failed nuts and bolts 101. I recommend all the time to young people to go into your profession. I believe it has a great future. But anyway, I do know my trade management.

Tharp expectancy is wonderful in the test world. But, not a single site or author including Tharp will tell a trader how to use expectancy once you begin live trading for trade management (the subject of this forum). When you ask them to give one solid example of expectancy in live trading they all clam up. That is because there are no examples.

Expectancy is a prime example of useless statistics. If you look at expectancy on web sites they all post a variation of Tharp. I showed 3 different versions of expectancy touted by “super traders”. If you look there are many more versions of expectancy each interpreted totally different. These authors and “super traders” tout this clap trap to mesmerize the starting trader in to believing these are some kind of magic formulas. And right on queue these pawns spout this statistical nonsense as the gospel of trading.

My point is simple Jimbojim. Traders (most of whom have never traded) post nonsense on ET forums and all over the web about how to manage live trades using fancy statistical measurements they no nothing about. They are all under the impression that if you have a positive expectancy in testing you will make big bucks in live trading. Nothing is farther from the truth. There is no correlation between positive expectancy and making profits. Expectancy is like an alternator test on a car. It may test positive saying the alternator is good in the shop but fail by shorting on the street under live conditions.

I will say it again. This is a trade management forum. That means how is expectancy used to manage live trading. I don’t care about computing expectancy before I trade. That is well documented. I keep asking the same trade management questions and no trader ever responds. Some of the questions are:
“When I’m in the middle of live trading how will the original expectancy number improve my trading results?”
“When I do a performance review of my live trades what role does expectancy play?”
“When I have a base of live trading performance do I recomputed the expectancy from live trades as my new expectancy guideline?”
“When does negative expectancy in live trading indicate I should shut down my automated trading?”

 

Rabbitone, I haven't mentioned using perceived expected value for trading at all. You also seem to be confusing expected value with perceived expected value. The expected value is the true value, while the perceived value is what we calculate it to be, whether it is for a single trade or over a large sample. There is always a true expected value, we just never know what it is (not for most types of trading).

Of course, this true expected value won't exist if you don't believe that probabilities exist for every event, but if that is the case then trading wouldn't be logical.

Again, my point is that what matters is that we place good trades and size them correctly. I'm growing weary of repeating this, as you have a completely different debate going on in your head. Your posts have absolutely nothing to do with mine. Nothing at all. Obviously, you're just seeing what you want to see, have a chip on your shoulder, an agenda or something similar. There's no point discussing this any further.

 

Mr J It seems you and I will be at odds forever. You are right. It’s impossible to get a word in edgewise with you. You have refused to answer a single question I posed to you. But I have attempted to answer yours. So here goes.

Instead of answering my questions you go off on wild tangents. In this message you extrapolated expected value into a new set of terminology that no one has ever heard of trying to prove your point. You write about “Perceived expected value” and “True expected value” where no such terminology exists.

Then you say my posts have nothing to do yours. That is not true. And no I have no chip on my shoulder. Then why do I continue to write. It all goes back to your original statement which I ask you to defend (and you have failed to do so):

“If you practice sensible capital management, the risk to reward is irrelevant. All that matters is that the trade is +ev and appropriately sized.”

The first point about this statement is simple. Expected value is useful once during testing as a filter to say a strategy passes or fails the test for trading. That is what traders use it for. However, beyond that point when you try to use expected value in live trading it is useless. Because it is useless in live trading no trader should hang their hat on expectancy as the sole context of making profits (with sizing).

A second point is also important. Because a strategy has passed the expected value test and is appropriately sized does not mean it will make profits. It is not all that matters. If I used that as my only trading criteria I would have been broke 10 years ago. Your categorical statement has blatant disregard for the other factors that have a direct relationship to making profits with a trading strategy.

The third point is just as important. Some strategies do depend on risk reward as their trading criteria. I have trend following strategies that will not make profits unless the Risk Reward is high enough.

And the last point. The expected value derived from live trades is more often than not nowhere near the calculated one in test for a profitable strategy. Expected value does not have predictive value.

You said there is no point in discussing this further. Maybe…But, I’m retired with all day to write while my non expectant risk reward strategies make nice profits. So write soon.

 

The problem is we're addressing different things.

" You write about “Perceived expected value” and “True expected value” where no such terminology exists."

They're not technical terms. I added in "perceived" and "true" to differentiate between the true probabilities and value of an event, and what we as humans calculate it to be. What is important to understand is that our calculations are rarely accurate, so the true probabilities and outcomes of an event will differ from what we calculate them to be. For example, we may calculate a coin toss to be 50/50, when in reality there is a slim chance that it will land standing up. Here, our 50/50 calculation is not quite correct. Our calculations on probability are almost never correct, and therefore our calculation of ev can almost never be correct. If you accept this, then agreeing with the concept of perceived and true value should follow.

"It all goes back to your original statement which I ask you to defend (and you have failed to do so):"

I have addressed my original statement many times, but you seem to just ignore it. Again, my original point was simply to say that a specific R:R ratio was not a requirement for a good trade. Good trades make good trades, and while it sounds quite obvious, I think someone who actually thinks about that statement and has the right frame of mind will see the value in it.

"Expected value is useful once during testing as a filter to say a strategy passes or fails the test for trading. That is what traders use it for."

The problem is that you seem to think that expected value is simply the value we calculate from a sample of results. It isn't. Ev is always real-time, since it exists for every decision we make. It is always existent and constantly changes.

"Because a strategy has passed the expected value test and is appropriately sized does not mean it will make profits."

This confirms that you don't understand my posts because I agree with your point here. I'm not talking about the calculations of ev we get from testing a strategy over a statistically significant sample.

This whole discussion comes down to you not realising that value is not simply a figure that we calculate over a sample, and therefore you assume I'm talking about the figure we do calculate over a sample.

I believe this is your argument:
Ev is not all important, because strategies that are tested over a sample and calculated to be +ev are often unprofitable strategies.

I never suggested otherwise, and it really does have nothing to do with my point.

 

Mr J it is nice to have you back to talk with about this subject near and dear to both of us. For a second let us digress from these messages and pose this problem in a different way and take a new tact. Bear with me and you will understand where I am coming from.

I, like other traders for the past 15 years of trading systems have been trying to reconcile the bewildering vast number of statistics that are spewed from guru’s books and articles on trading. When my systems began to show profits about 12 years ago I tried in vain to apply and use these “brilliant” statistical jewels to improve my trades. What I found are most of the rules of thumb these gurus’s spill out are useless because they are not thought out. They are brilliant one liner’s that cost all of us profits.

So I began to build my own methods, correlations and rules of thumb. I went back to my roots as a manager of database administration and applied IBM’s methods of performance management to trade management. To use this method both testing and live trading must be equal parts in the equation. What works in one must work in other. The rules of this method are not hard to understand. They state:
1. Performance measurements must be consistent with each test.
2. What you apply in testing (optimization) must be verified in production (live trading).
3. Performance must be integrated between all components to be effective (integrated with other parts of trade management).

Now let us look at different area and apply these rules; this ones a classic example (I will get back to expected value in a second).

Guru rule 1 from one web site: “…Use a fixed fractional position sizing… For example, you might risk 2% of your account equity on each trade (the "2% rule"). …”

Guru rule 2 from another web site “…we cannot risk more than 6% of our trading account when we enter multiple positions at the same time …”

Guru rule 3 from another web site “…You should not exceed 8% over all losses in month. In other words, the most you can lose in month or total trading account loss is 8%...”

Good rules. But try to back them into to an automated system in testing and live trading.
My rule 3 says integrate these 3 rules into one system. Lets see… if I use the wrong fixed fractional position sizing I end up shutting my system down from rule 2 and rule 3… The point is you rarely, if ever, see examples from these guru’s that integrate all of there wisdom in to one system in live trading.

Then there is expected value. When I optimize a typical trading system I get 200 profitable settings. When I dump the trade data to my database and SQL it all 200 have a positive expected value? However when I forward test only 8 settings are profitable? So expected value has no predictive quality and is not consistent across testing (same result last 8 years).

When the forward tested strategy settings live trades are examined, guess what? The expected value from testing has no relationship or correlation to actual results. Yet the system made money? Go figure? When I compute the actual result using the EV formula some times the number is half and other times it is twice. But it is never the same. The conclusion is expected value has no predictive value or correlation to actual trading results. Fluke? Maybe …. but it has been running that way for years and every time I ask for some proof that this is a fluke to refute my individual case history all I get is parroted guru statements. If I’m wrong so be it. It could be my way of writing code. But no one has ever stepped up to plate with live stats or examples to prove their case…

Trade management is quality control ( I am a six sigma fan). What you apply in testing must show positive results in live trading or don’t use it. What I have done for the past 6 years is find out what trade management factors for each of my strategies in test correlate directly to live trading. I have a long way to go. But using my 3 rules I now know what does and does not work for many of my trading strategies.

Expected value doesn’t work for me. Expected value like many other guru statistics does not correlate (because it constantly changes as you note) to building better positive trading results for me. It is a simplistic general statistic. It is no help in deciding which automated strategy setting to trade. Picking a strategy setting based on expected value alone would lead 96 times out of a 100 times to a losing system execution according to my results.

My goal is better positive trading results. Not performing calculations some guru says are excellent. I’m still wait to hear how expected value builds positive value into any trading strategy. My point is expected value does nothing to produce good trades (your main point). Where I do have strategys that depend on high R:R and market conditions or they will not produce good trades (positve correlation in test and live trading confirmed multiple times).

Mr J please write back. This gets what little adrenaline that is left in my old body in play. Now I have enough energy to get my dogs to the vet this afternoon. Thanks.

 

If a bear flag has a minimum of 5 bars, but less than 12 bars, when/if the low of the bear flag is breached, there is an 86% probability that an ensuing move down will be a measured move down, at least. Hence, the measured move is an un-quantified expectancy.

Since a measured move is unique, based on a specific slice of price and/or time, the expectancy is not nominally quantified ahead of time.

As a trader, YOU must determine if the expectancy is worth trading. One hour you might see a bear flag, an 86% probability if broken, to attain a 40 tic measured move in the YM... later in the day you see a bear flag with an 86% probability if broken, to attain a 12 tic measured move. Same basis, but completely different nominal expectancy. Yet the expectancy remains and is 100% valid.

If you want to quantify the expectancy, you are free to make YOUR own analysis ... perhaps there is a 99% probability to attain a 2 tic move irregardless of measurement. I don't know. That becomes YOUR edge, AND contains YOUR "quantified" expectancy. If you need to ask how that would/could be determined, I can not help.

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