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TECHNIQUE: After three profitable trades, skipping the next setup.
Maybe im missing something but if this is true and that the odds of every trade are therefore 50% (in our hypothetical example we've been running with), then is it not unreasonable to think that the original posts question of stopping after 3 or 'x' amount of winners would be valid? I believe you had stated earlier agreeing with the premise that every trade was a independent event. So then just like Paiges coin toss example the outcome of every trade would be a flat 50/50 but still the odds of having runs of 4-5 consecutive losses or gains diminish over time therefore giving some validity to stopping after a winning streak.
regarding historical testing, i do believe that it helps to understand the odds of a particular scenario occurring and what the outcome may be. but an edge is developed in how those trades are executed and managed, something i think should be relative to how the current market is trading which cant be deduced by historical events. not saying that this is the only view just my own deduction after having so many "backtested mechanical systems" utterly fail. probably due to my inability to trade them lol.
This goes back to the concept of gambler's fallacy. If your trades are independent, there is no benefit from stopping after a winning or losing streak.
One reason so many backtested mechanical systems fail is because people build them incorrectly. And like you say, another reason is due to people being unable to faithfully trade them.
I am afraid I also don't agree with that statement. If thousands of historical trades provided 50/50 odds, then there should be a very strong expectation that this should continue in the future. However, that does not mean that external events could not impact these odds going forward. Look at the roaring 20s as an example - all you needed to do was buy the dips and you would have great odds in you favour. Trying such a strategy in the 30s would most likely have produced vastly different results. Even if you had a sample of 1000s of trades in the 20s, your odds would have changed significantly in the 30s. This may be an extreme example, but I would wager that determining the exact odds of any trade is impossible purely because it is impossible to account for all of the variables that change from trade to trade.
Note that it does not imply historical testing is useless. I am of the view that backtesting provides an extremely valuable indication of whether systems are viable. However, I have always found that win% varies quite a bit from period to period. Maybe I have not tested enough systems, maybe my system were too long-term in nature, or my testing and validation was not rigorous enough, but I just found that in my testing the win% did not stay constant once newer data was introduced.
That is an important point: In the short run (say a few hundred trades), the outcome may be quite a bit different than than the long run (thousands of trades). That could be due to randomness, or it could be something more (like a structural change in the market).
Throughout this, my assumption has been that a trader would never factor in " any condition or conditions" that had proven to be unprofitable or served to invalidate, or in any way, skew a setup's expectation. For example, I would never take (or hold) my favorite setup following/through a Fed announcement. Or if airliners apparently started flying into skyscrapers or if there was a leak at a major nuclear power plant. And also, as someone said, if the setup's expectation was positive at one part or the day and negative during another period. But then again. I would not expect a zero expectation tossing a coin that I didn't believe was unbiased, either. I may very well come out a winner, but I'd have no reason to *expect* to. So yes, market conditions or events can change the dynamic of a statistically positive setup --- but the setups which occur during such periods should have never been included in the calculation of your expectation to begin with.
But the original posters' question (at least my interpretation of it) --- was whether 3 wins in a row could create a statistical probability of losing on the 4th trade -- based solely on the fact that 3 consecutive wins had just occurred. To which the answer is absolutely not. The expectation on the 4th trade (whatever it was) is basically the same as it was on the third trade.
Ironically enough, 3 consecutive wins would actually increase your expectation on the 4th trade --- certainly not decrease it.
The lottery is a punishment for those who do not understand statistics.
Matt Z
Optimus Futures
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