Why favorable R:R?

[intradaybill]

Quote from college_trad3r:

you have to look at the expectancy of the probability...

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

 

[Specterx]

Quote from riskfreetrading:

You have put your finger on a key question in trading. I have developed a problem which I call "The Monkey Trading Problem" to prove the exact nature of what you have encountered, and how to deal with it.

Please search for it, and post the link here. Thank you (It is the education or professional forum). Posted on December 11 (early hours of the morning).

Continue your good thinking. You are on the right path, but not quite there yet from what I understand from your post.

I believe this is what you're talking about:

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

If you wonder whether you know trading knowledge, answer this question (pros/winners know the answer explicitely and implicitely):

1. Consider a monkey that makes trading calls on an index. The Monkey puts a stop loss X. We want to know the ratio of the probability of trade stopage to the probability the monkey makes X dollars or more on his trade. What is that ratio?

2. Would monkey have zero, positive, or negative expectancy.

3. Could you give some easy to implement rules to increase the expectancy of a monkey trade.

PS: Our monkey is nothing else than the sum of all traders in the market (the average trader). Half the traders are worse than the monkey but they may not realize it explicitely. All losing traders are definitely worse than the monkey trading explained above.

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.

 

[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

 

[intradaybill]

Quote from Specterx:

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).

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.

 

[intradaybill]

Quote from 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

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.

 

[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.

 

[ronblack]

Quote from 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

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

 

[nkhoi]

Quote from frostengine:

..
Hence, their is no obvious reason I see to strive for a ratio such as 3:1...,,,

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

 

[jficquette]

Quote from dandxg:

Expectancy is much more important than pure R to R.

Yes let expectancy drive stop placement. Not the other way around.

 

[bigarrow]

Quote from 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

I think stops have to be based on entry points at least to extent to what the trader wants to risk.