<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>
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>
