Prudent Risk Management Is The Only True Edge In TRADING

[JSSPMK]

Eganon - You dont MAKE your own odds.

I disagree. I always make my own odds by evaluating potential expansion range and setting my stop accordingly. Just because it doesn't always work out in my favour doesn't change the fact that I expect minimum odds of 2/1 (fractions) 3 (decimal). If I am going for a bigger move than I aim for much better odds.

Did you not hear Jack Schwager say that after having interviewed various top successful traders his research established that as far as they were concerned risk management played a bigger part than methodology? It's not about being right more often than not, that's always a random outcome (streaks come and go). It's about correct position sizing, management and realistic reward expectations, that's the main reason majority do fail, because they ignore that part almost completely whilst concentrating almost completely on win rate and you know what, that's absolutely normal, there was a survey carried out that established that vast majority of people simply couldn't tolerate low win rate - they would simply quit if presented with it. I say it's way easier to establish a low win rate by implementing PRM than to establish a consistently high win method/strategy. Most that tried have failed, gave many years of their lives looking for the holy grail (high win rate edge).

 

[JSSPMK]

Look at sports betting tipster world, vast majority of football tipsters (in UK) tip at very low odds of 1.2-1.5, the best ones have a win rate of around 80% running average, yet the best performance that I have observed came from higher odd tipsters that had a much smaller following due to being inconsistent, their odds were around 4-5 (decimal). But at the end their Tally generated higher point count.

 

[JSSPMK]

Look at sports betting tipster world, vast majority of football tipsters (in UK) tip at very low odds of 1.2-1.5, the best ones have a win rate of around 80% running average, yet the best performance that I have observed came from higher odd tipsters that had a much smaller following due to being inconsistent, their odds were around 4-5 (decimal). But at the end their Tally generated higher point count.

I don't study football stats, so I don't know who has better chance of winning, etc. What I do know is that both teams will try to score at least 1 goal, just for fun, I've just placed 10 treble accumulator bets on BOTH TEAMS TO SCORE, my overall loss is limited to £10 and average odds are around 7 (decimal). I'll let you know how I got on

 

[eganon69]

Eganon - You dont MAKE your own odds.

I disagree. I always make my own odds by evaluating potential expansion range and setting my stop accordingly. Just because it doesn't always work out in my favour doesn't change the fact that I expect minimum odds of 2/1 (fractions) 3 (decimal). If I am going for a bigger move than I aim for much better odds.

Did you not hear Jack Schwager say that after having interviewed various top successful traders his research established that as far as they were concerned risk management played a bigger part than methodology? It's not about being right more often than not, that's always a random outcome (streaks come and go). It's about correct position sizing, management and realistic reward expectations, that's the main reason majority do fail, because they ignore that part almost completely whilst concentrating almost completely on win rate and you know what, that's absolutely normal, there was a survey carried out that established that vast majority of people simply couldn't tolerate low win rate - they would simply quit if presented with it. I say it's way easier to establish a low win rate by implementing PRM than to establish a consistently high win method/strategy. Most that tried have failed, gave many years of their lives looking for the holy grail (high win rate edge).

I think you and I are saying the same things. Just in different ways perhaps. But a Holy Grail system is not one with a High Win Rate. Nor is it one with the Highest Positive Expectancy. Its the one that had BOTH and then you maximize it with PRM. Most systems have a blend of win rate and Expectancy and are acceptable systems. Yes absolutely PRM is critical. My point is simply that PRM IN AND OF ITSELF is NOT going to make you profitable. You MUST have a Positive Expectancy and THEN AND ONLY THEN will PRM help you MAXIMIZE the results of your system for maximum profit with acceptable drawdown. I think a better trading proverb would be "Limit Losses and the Winners will take care of themselves Assuming you have a Positive Expectancy"

You need BOTH a Positive Expectancy AND PRM. Either one alone is not enough. But the "Edge" is what gets you the Positive Expectancy (Profitable system) and PRM maximizes the expectancy.

For further reference read Van Tharpe's books like "Trade You Way to Financial Freedom" or "The Definitive Guide to Position Sizing". They are very good in my opinion.

 

[JSSPMK]

I think you and I are saying the same things. Just in different ways perhaps. But a Holy Grail system is not one with a High Win Rate. Nor is it one with the Highest Positive Expectancy. Its the one that had BOTH and then you maximize it with PRM. Most systems have a blend of win rate and Expectancy and are acceptable systems. Yes absolutely PRM is critical. My point is simply that PRM IN AND OF ITSELF is NOT going to make you profitable. You MUST have a Positive Expectancy and THEN AND ONLY THEN will PRM help you MAXIMIZE the results of your system for maximum profit with acceptable drawdown. I think a better trading proverb would be "Limit Losses and the Winners will take care of themselves Assuming you have a Positive Expectancy"

You need BOTH a Positive Expectancy AND PRM. Either one alone is not enough. But the "Edge" is what gets you the Positive Expectancy (Profitable system) and PRM maximizes the expectancy.

For further reference read Van Tharpe's books like "Trade You Way to Financial Freedom" or "The Definitive Guide to Position Sizing". They are very good in my opinion.

You say 'positive expectancy', could you possibly explain what does that mean to you, what is it based on.

 

[eganon69]

You say 'positive expectancy', could you possibly explain what does that mean to you, what is it based on.

Think of Expectancy as your profit in a business.

Expectancy = (Probability of WINNING × AVERAGE $WIN) - (Probability LOSING × AVERAGE $LOSS)

This number has to be Positive.

1) If Win Rate is 70% and Average Win is $50 and Average Loss is $100 then

Expectancy = [(.70 * $50) - (0.3 * $100)] = $35-$30 = $5 = POSITIVE

This system is a winner but not a great one.

2) If Win Rate is 50% and Avg Win is $100 and Average Loss is $100 (PERFECT Coin Flip System)

Expectancy = [(0.5 * $100) - (0.5 * $100)] = $50-$50 = ZERO

This system is a loser because no one trades 100% perfectly every trade and this does not likely account for commisions. This system has ZERO hope of being Profitable no matter what PRM you want to emplore.

3) If Win Rate is 50% and Avg Win is $130 and Avg Loss is $95

Expectancy = [(0.50 * $130) - (0.50 * $95)] = $65 - $42.75 = $22.75 = POSITIVE

- If Win Rate is 40% and Avg Win is $200 and Avg Loss is $95

Expectancy = $23 = POSITIVE

Notice these last 2 systems were SIMILAR POSITIVE Expectancy even though win rate was different. The better of the 2 systems is likely the 50% win rate one because you will have smaller losing streaks (higher win rate) and less drawdown of your capital so you can risk a bit more than the guy using the 40% win rate system.

4) If Win Rate is 60% and Avg Win is $80 and Avg Loss is $95

Expectancy = $10 POSITIVE

- If Win Rate is 55% and Avg Win is $75 and Avg Loss is $95

Expectancy = -$1.50 = NEGATIVE

Notice these last 2 systems were similar win rate and average win amount but one is a failing system and the other is at least positive but probably a marginal system. PRM will help the 1st of these to maximize his gain and the 2nd of these is a loser no matter what.

You need BOTH Positive Expectancy AND PRM to maximize a system and be as profitable as possible with as little drawdown as you can reasonably accept.

 

[JSSPMK]

Think of Expectancy as your profit in a business.

Expectancy = (Probability of WINNING × AVERAGE $WIN) - (Probability LOSING × AVERAGE $LOSS)

This number has to be Positive.

1) If Win Rate is 70% and Average Win is $50 and Average Loss is $100 then

Expectancy = [(.70 * $50) - (0.3 * $100)] = $35-$30 = $5 = POSITIVE

This system is a winner but not a great one.

2) If Win Rate is 50% and Avg Win is $100 and Average Loss is $100 (PERFECT Coin Flip System)

Expectancy = [(0.5 * $100) - (0.5 * $100)] = $50-$50 = ZERO

This system is a loser because no one trades 100% perfectly every trade and this does not likely account for commisions. This system has ZERO hope of being Profitable no matter what PRM you want to emplore.

3) If Win Rate is 50% and Avg Win is $130 and Avg Loss is $95

Expectancy = [(0.50 * $130) - (0.50 * $95)] = $65 - $42.75 = $22.75 = POSITIVE

- If Win Rate is 40% and Avg Win is $200 and Avg Loss is $95

Expectancy = $23 = POSITIVE

Notice these last 2 systems were SIMILAR POSITIVE Expectancy even though win rate was different. The better of the 2 systems is likely the 50% win rate one because you will have smaller losing streaks (higher win rate) and less drawdown of your capital so you can risk a bit more than the guy using the 40% win rate system.

4) If Win Rate is 60% and Avg Win is $80 and Avg Loss is $95

Expectancy = $10 POSITIVE

- If Win Rate is 55% and Avg Win is $75 and Avg Loss is $95

Expectancy = -$1.50 = NEGATIVE

Notice these last 2 systems were similar win rate and average win amount but one is a failing system and the other is at least positive but probably a marginal system. PRM will help the 1st of these to maximize his gain and the 2nd of these is a loser no matter what.

You need BOTH Positive Expectancy AND PRM to maximize a system and be as profitable as possible with as little drawdown as you can reasonably accept.

OK. PE is part of PRM (to me). Establishing historical range expansion, stop requirement and historical win rate based on the above criteria are all part of PRM.

 

[Buy1Sell2]

You do not understand the standard definition of "positive expectancy". The definition that is used by mathematicians, hedge funds, casinos , pro gamblers, etc

This term is independent of money management and refers to your advantage or disadvantage on your bets.

IE- if every dollar wagered is worth 1.20 ( in the long run ) that is positive expectancy. If every dollars is worth 95 cents in the long run that is negative expectancy.

Betting on a fair coin flip at even money would have neutral expectancy.

Betting heads on a coin rigged to flip heads 60 percent of the time gives you positive expectancy and gives your opponent negative expectancy.

Anothet example: the house edge on the standard double zero roulette game is 5.26%. So in the long run you are losing roughly 5 dollars and 26 cents for every 100 dollars you bet if you play this game.

There is no prudent money management scheme that will make you a winner in the above mentioned coin flipping game or in the roulette game.

_____


However, yes, without reasonable money management a trader will probably lose his account even if he has an advantage.

If his money management is horrendous, he will definitely lose his account if he keeps trading.

There is no money management scheme that beats a negative expectancy game like trading badly over and over, like if your entries were based on coin flips and held to the days end (slippage and commissions)

What is needed is both:

1. A worthwhile advantage on your trades

2. Reasonable money management

... this is how top traders, hedge funds, casinos, pro gamblers do it.

I agree with the spirit of your nod to the importance of good risk management.

However, in point of fact though, your post is not correct because "positive expectancy" has an exact and technical meaning.

Positive expectancy is the ability to have a winning system , it does not apply to a singular trade. PRM gives you the positive expectancy over the long haul because it cuts you out of big losses and keeps you in big winners. Ask an unsuccessful trader if they had ability to pick direction and they will say yes. Then , ask that same trader why they weren't successful and they will tell you that they took losses that were bigger than their gains and that they pulled out of winning trades only to watch them move farther in the direction they had initially wanted envisioned.

 

[Buy1Sell2]

Thus it can be easily seen that successful traders have a certain edge over other traders and that is the ability to implement PRM. ---There is no other edge available to the trader.

 

[Buy1Sell2]

Most people who trade do not understand what positive expectancy is.