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The question of an edge


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The question of an edge

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  #1 (permalink)
no drama Llama
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Dude: I want to try this new strategy on this instrument what do ya-all think?
Trader: Whats your statistical back tested edge?
Dude: .............


How do you reduce something so complex down to a single question like that and expect an answer? Most times it can take an entire journal and we still wont know what a traders edge is.

Can it be reduced down to a mere statistic?
Can it be based any one of the following things?
1. superior money management?
2. Iron clad discipline?
3. Phsychology?
4. Journaling and record keeping?
5. Accomplished technical ability?
6. Profoundly deep understanding of fundamentals?
7. Gigabyes of back tested data?
8. Reams of forward tested data?
9. Thousands of hours of screen time?
I can go on...


You might think that your edge is your ability to execute this one thing repeatedly which your spreadsheet tells you statistically works out in your favour 55% of the time (or whatever). If it is that simple then why cant someone else take your strategy and trade it because we all know that doesnt work?
Your edge is the sum total of everything you have been through on your journey to become a trader. Everything I have listed is important and is an edge in itself. Backtested statistical data is just one piece of it.

What do you think?

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  #3 (permalink)
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Grantx View Post
Dude: I want to try this new strategy on this instrument what do ya-all think?
Trader: Whats your statistical back tested edge?
Dude: .............


How do you reduce something so complex down to a single question like that and expect an answer? Most times it can take an entire journal and we still wont know what a traders edge is.

Can it be reduced down to a mere statistic?

Yes, it is called expectancy.

If you don't have positive expectancy, many of the other things on your list (iron clad discipline, superior money management, thousands of hours of screen time, journaling, etc) become irrelevant.

But, if you do have a positive expectancy edge, many of those items you listed DO become important. Example: with poor money management, you can easily get wiped out even with a positive expectancy system.

It all starts with positive expectancy - if you lack that, you will eventually be screwed.

Think of it like building a castle. You need a solid foundation (Positive expectancy) before building the castle (other items in your list). Because as Jimi Hendrix said "castles made of sand, fall in the sea, eventually."

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  #4 (permalink)
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This is an interesting topic, as I have wrestled with these issues for a long time. I would pose two related questions that try to get at the heart of the matter:
  1. Is a trading strategy only valid if it can be coded and run by a computer? (Assume the coder is highly competent)
  2. Can a purely discretionary strategy truly have an "edge?" (If it does, see question #1).

One "out" that the discretionary traders always take is "context." i.e., "I would take THIS entry, but not THAT (identical-looking) entry b/c the "bad" entry is too close to resistance." Mack from PATS is big on context, but appears to be successful. Same with Bob Volman, Al Brooks, Sam Seiden, etc.

Assuming pure discretionary price action type methods have an "edge," is there 1,000 (or 10,000) lines of computer code that could encapsulate all of the "context" and exceptions to the rule that would verify the edge?

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drm7 View Post
This is an interesting topic, as I have wrestled with these issues for a long time. I would pose two related questions that try to get at the heart of the matter:
  1. Is a trading strategy only valid if it can be coded and run by a computer? (Assume the coder is highly competent)
  2. Can a purely discretionary strategy truly have an "edge?" (If it does, see question #1).

One "out" that the discretionary traders always take is "context." i.e., "I would take THIS entry, but not THAT (identical-looking) entry b/c the "bad" entry is too close to resistance." Mack from PATS is big on context, but appears to be successful. Same with Bob Volman, Al Brooks, Sam Seiden, etc.

Assuming pure discretionary price action type methods have an "edge," is there 1,000 (or 10,000) lines of computer code that could encapsulate all of the "context" and exceptions to the rule that would verify the edge?

1. no
2. yes


Discretionary traders can indeed have positive expectancy. The approach might be impossible to backtest, though.

Regardless of trading style, you can always use actual real money results to determine expectancy/edge.

Some methods cannot be backtested, and backtests can easily be faked/manipulated/etc. Backtests are definitely not foolproof.

As for your list of discretionary traders, I have my doubts about some of them having an edge (or even trading at all), and I'll leave it at that.

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kevinkdog View Post
Yes, it is called expectancy.

If you don't have positive expectancy, many of the other things on your list (iron clad discipline, superior money management, thousands of hours of screen time, journaling, etc) become irrelevant.

But, if you do have a positive expectancy edge, many of those items you listed DO become important. Example: with poor money management, you can easily get wiped out even with a positive expectancy system.

It all starts with positive expectancy - if you lack that, you will eventually be screwed.

Think of it like building a castle. You need a solid foundation (Positive expectancy) before building the castle (other items in your list). Because as Jimi Hendrix said "castles made of sand, fall in the sea, eventually."

Positive expectancy is the sum of the parts and fluctuates along in direct response to the input. Its a representation of how disciplined you are with all the points listed (and others).

Firstly, to ask the question 'what do you think of this or that strategy' is a silly thing to ask in the first place. But equally baffling is to ask whats your edge or do you have a positive expectancy? Edge and expectancy is only relevant right now, because these metrics can change. You cant rely on your expectancy for anything. Or can you? What do you do with it?

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kevinkdog View Post
1. no
2. yes


Discretionary traders can indeed have positive expectancy. The approach might be impossible to backtest, though.

Regardless of trading style, you can always use actual real money results to determine expectancy/edge.

Some methods cannot be backtested, and backtests can easily be faked/manipulated/etc. Backtests are definitely not foolproof.

As for your list of discretionary traders, I have my doubts about some of them having an edge (or even trading at all), and I'll leave it at that.

I Agree...
I can even say more..

There can be an 'edge', which by eye-balling the screen is very clear, why long, why short, why don't touch
once you want to quantify it (at least in classic rule-based system) and program it, it becomes very very
difficult as there is always a little 'but', which is evident to the human eye/brain, but when not programmed
it doesn't count...

Today half of my strategies are classic rule based, if / then and work OK
other half are machine learning, artificial intelligence based

I'm currently working on a small new project, and teach my kid (university student) the magic of machine
learning. as a example i hope to illustrate the result of a rules based system compared to a machine learning
system. But on the same concept... The goal of the exercise is : manual, trial/error/optimisation of features
and parameters, compared to automatic feature extraction... will be a good interesting exercise

More to follow this month...

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rleplae View Post
There can be an 'edge', which by eye-balling the screen is very clear, why long, why short, why don't touch
once you want to quantify it (at least in classic rule-based system) and program it, it becomes very very
difficult as there is always a little 'but', which is evident to the human eye/brain, but when not programmed
it doesn't count...

Today half of my strategies are classic rule based, if / then and work OK
other half are machine learning, artificial intelligence based

I'm currently working on a small new project, and teach my kid (university student) the magic of machine
learning. as a example i hope to illustrate the result of a rules based system compared to a machine learning
system. But on the same concept... The goal of the exercise is : manual, trial/error/optimisation of features
and parameters, compared to automatic feature extraction... will be a good interesting exercise

More to follow this month...

Like the sound of the project, have a similar plan in incubation, good hunting.

However, regarding 'the edge' I'm afraid 90% is illusion caused by the magic of whole charts and hindsight, there is only 'the right-hand edge' when we're live...

Cheers

Travel Well
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Grantx View Post
Positive expectancy is the sum of the parts and fluctuates along in direct response to the input. Its a representation of how disciplined you are with all the points listed (and others).

Firstly, to ask the question 'what do you think of this or that strategy' is a silly thing to ask in the first place. But equally baffling is to ask whats your edge or do you have a positive expectancy? Edge and expectancy is only relevant right now, because these metrics can change. You cant rely on your expectancy for anything. Or can you? What do you do with it?


I'm unsure how to answer your questions, but I will share this:

1. Any hedge fund or Commodity Trading Advisor will always ask you what you think your edge is, if they want you to trade with them

2. Just because you have an edge the last week/month/year/decade does not guarantee you'll have one the next week/month/year/decade

3. If you do not know what your edge is, chances are you probably do not even have one

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Grantx View Post
Positive expectancy is the sum of the parts and fluctuates along in direct response to the input. Its a representation of how disciplined you are with all the points listed (and others).

Firstly, to ask the question 'what do you think of this or that strategy' is a silly thing to ask in the first place. But equally baffling is to ask whats your edge or do you have a positive expectancy? Edge and expectancy is only relevant right now, because these metrics can change. You cant rely on your expectancy for anything. Or can you? What do you do with it?

I'm sorry, but you're wrong. You can't conjure profit through positive thoughts, writing in a journal, screen time or discipline in financial markets. If what you are doing is mathematically unsound you will lose. Those things you listed are prerequisite to success and may help you adjust yourself to attaining an edge. By themselves they do not equal one. You must have a positive mathematical expectancy. Everything else is secondary.

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TheShrike View Post
Those things you listed are prerequisite to success and may help you adjust yourself to attaining an edge. By themselves they do not equal one.

Thats what I am saying, the sum total of those things=your edge so how do you describe it or encapsulate it all into a single mathematical statistic?

As far as I am concerned, a positive expectancy sounds just like the gamblers fallacy where you flip 3 heads in a row and you then have this expectation that the 4th will be the same. Expectancy only represents what you have done to date and has no bearing on future results. The same with your actual strategy, what you rely on today could be quite different in a years time. The only constants that you can safely rely on are the things in that list (and a few other things).

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Grantx View Post
Thats what I am saying, the sum total of those things=your edge so how do you describe it or encapsulate it all into a single mathematical statistic?

As far as I am concerned, a positive expectancy sounds just like the gamblers fallacy where you flip 3 heads in a row and you then have this expectation that the 4th will be the same. Expectancy only represents what you have done to date and has no bearing on future results. The same with your actual strategy, what you rely on today could be quite different in a years time. The only constants that you can safely rely on are the things in that list (and a few other things).

If you think "positive expectancy" is the same as gambler's fallacy, I am confident you do not understand expectancy and how it can be of benefit.

Based on 25+ years of doing this, I can tell you I put a whole lot more faith in being successful by trading positive expectancy strategies than by journaling my thoughts...

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kevinkdog View Post
I am confident you do not understand expectancy and how it can be of benefit.
.

You are absolutely right. I dont understand.

And I am glad that I asked the original question because I have traders such as yourself with 25+ years of experience giving a lesson that didn't take me years to figure out the hard way

Thank you. Ill be focusing on my mathematical +expectancy going forward.

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With the benefit of Two Pints of Old Peculier I am actually 100% sure that the positive mathematical expectancy for a strategy lasts no longer than the market conditions in which that strategy performs successfully do.

A good friend who used to work for me became CTO of a large risk metrics outfit employing c50 Phd's. He confessed that the biggest problem he had was that they actually believed in what they did. Sometimes reality needs common sense to see past the numbers, as well as debunk the beliefs.

Cheers

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Interesting conversation, thanks for starting it @Grantx.

I agree with @kevinkdog’s statement that expectancy is edge and @TheShrike's comment that the things listed in the OP are prerequisites and not "edge" but I understand the difficulty in quantifying it for a discretionary trader. It’s not as simple as saying that ‘I go long when the 20 EMA crosses above the 50 EMA and this has a hit rate of X% and positive expectancy of 0.X% over a series of 1,000 trades.’

Part of the problem for someone who identifies as a discretionary trader is to distill their “edge” into a single sentence or statement. I personally feel that if someone has proven to be consistently profitable (with a positive expectancy) over a large sample size of both trades and time then their discretion itself is their edge. This large sample size is essential because it has to entail numerous distinct market conditions as @ratfink alluded to. Good luck trying to summarize this into a single sentence or paragraph though.

I’ve seen many times the question be posed to someone on the site “what is your edge?” I feel it’s a catch 22 just like when someone applies for their first job. It’s tough to get a job without experience but you need a job to get experience. The same applies to a discretionary edge. You can’t be consistently profitable without an edge but you can’t prove edge without being consistently profitable.

I think if you posed the same question to a consistently profitable discretionary trader either past or present on this site to distill their “edge” into a single sentence, keeping it PG, they might quote Boris Johnson and tell you to “go whistle.”

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Grantx View Post
Dude: I want to try this new strategy on this instrument what do ya-all think?
Trader: Whats your statistical back tested edge?
Dude: .............


How do you reduce something so complex down to a single question like that and expect an answer? Most times it can take an entire journal and we still wont know what a traders edge is.

Well, asking a trader to define his edge is like asking a magician to show you how he sawed the lady in the half. They're probably asking, "Do you HAVE an edge?"

A better question might be: are there any successful futures traders who didn't understand their own edge? They made profitable trades but it was all just a mystical feeling when they bought and sold (?).

I think when someone asks if you have an edge, they're really asking, "Do you have any idea of what you're doing? Do you have a real trading strategy or are you just whimsically trading based on this week's newest indicator?"

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... having
• a positive expectancy,
• a working system
• programmed or not
• back tested or not
• 55% plus gains or not
• hundreds of hours screen time

BUT you face
• a new market field today (other than the past) AND
• you need to throw REAL money (yours or others) into the market...
• you need to PUSH the BUTTON (system or real time)
• your observance might overrule your strategy
• you might be pushing your stops further away
etc.
you know the whole story.

So having an edge is fine - but there is no proof either.
For the survival in the Future.

Good development!
GFIs1

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ratfink View Post
.....the positive mathematical expectancy for a strategy lasts no longer than the market conditions in which that strategy performs successfully do.

A good friend who used to work for me became CTO of a large risk metrics outfit employing c50 Phd's. He confessed that the biggest problem he had was that they actually believed in what they did. Sometimes reality needs common sense to see past the numbers, as well as debunk the beliefs.

Thanks, I have just finished a book and you have reminded me about 'When Genius Failed' by Roger Lowenstein (the demise of the LTCM hedge fund), one of my favourites. I will re-read that.

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i think i can call myself a full discretionary trader, which means the only tools i use for my trading is the Depth&Sales in futures trading and MarketMakerBox and Time&Sales in stocks trading. i watch the play between buyers and sellers and make my final decision on which side has control. Eg in a range we see buyer aggresiveness from support to resistance. then the price comes back to support bc buyers are loading up and dont want a breakout at this moment and sellers are not quite aggressive, price chopps back to support. finally buyers become more aggressive and breakout of the range. how do you want to backtest this? you can only gain this knowledge by watching the time&sales for monthes. how do you want to backtest fake orders on the order book. offer is pumping up and the same guy loading on the other side. no way to backtest it. you see it you join the party. if it goes in my favor i make 5 times more than it goes against me. there is no way you can backtest these things. i use highlowclose bar charts only to identify interesting price levels and thats it. and. to identify the market structure.


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Some things are difficult to backtest, but not impossible. For instance you can record the level 2 data, and write a bot that trades it. If you can't program you can just trade against an old days worth of data. That's why I have a journal where I post a video of my jigsaw DOM. So I can go back, review old data.

You can also forward test. It's ok to say there is a human element to your trades. However, without categorizing your trades by signal, and tracking the win/loss percentage, average win, and average loss, there is no way to know what your expectancy is. A signal could mean the opposite of what you thing, but because you don't track it you might never notice. Hence why it is critical to journal your trades.

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geth03 View Post
i think i can call myself a full discretionary trader, which means the only tools i use for my trading is the Depth&Sales in futures trading and MarketMakerBox and Time&Sales in stocks trading. i watch the play between buyers and sellers and make my final decision on which side has control. Eg in a range we see buyer aggresiveness from support to resistance. then the price comes back to support bc buyers are loading up and dont want a breakout at this moment and sellers are not quite aggressive, price chopps back to support. finally buyers become more aggressive and breakout of the range. how do you want to backtest this? you can only gain this knowledge by watching the time&sales for monthes. how do you want to backtest fake orders on the order book. offer is pumping up and the same guy loading on the other side. no way to backtest it. you see it you join the party. if it goes in my favor i make 5 times more than it goes against me. there is no way you can backtest these things. i use highlowclose bar charts only to identify interesting price levels and thats it. and. to identify the market structure.


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In a nutshell, the art of successful trading is to define who is in charge and to then jump on board. as long as your winnings exceed your losses you survive. You don't need an arsenal of tools, just your eyes and your brain, so many people are baffled by the bullsh-t.

Cheers cJohn

"Simplicity is the ultimate sophistication" Leonardo Da Vinci. Now there was a man who knew a thing or two about creating masterpieces.

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To refine my previous post of today:

There are systems that work quite well over some time.
Reaching the "end of consumption date" this system might no longer work.
Really?
Yes - really - POINT.
Depending on market conditions - some back and forth tested systems are
going the normal way of life: DOWN

Just be aware of this and test some other genius (bar) systems that might
have success.
Never be sure to have the holy grail for more than 1 year

The only thing that can make us optimistic:
The market will be here tomorrow again

GFIs1

If you are not sure - then watch @ratfink threads here who is telling you the truth
about finding the edge and about exquisite results - sometimes in sweat. Cheers!

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GFIs1 View Post
... exquisite results - sometimes in sweat. Cheers!

It's been a long time since my exquisite Sprint results, now much more like exquisite beer and sweaty results...

Cheers

Travel Well
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Let me add a different perspective to your question, first a hard "edge" would be something that is mathematically provable. Science is based on the idea that events are repeatable: it relies on a self-consistency assumption. If for whatever reason, things are different where I sit then where you sit, science itself would break down or more specifically, the scientific method would not yield useful results. A corollary to this idea that can be found in statistics is the normal distribution which many statistical methods assume or rely on to produce meaningful results. However, markets are non stationary which simply means that there are periods of both trend and range. Truthfully, markets are chaotic in nature. A different kind of mathematics would be required to elucidate any deeper truths.

As you eluded too, there are different types of edges in the market. If my trading cost are less then yours, I have a relative edge. That translates to my making more then you --even if we were to take the exact same trades: in some cases, that could even translate to my ability to consistently make money while you could be losing money.

What most traders talk about when they talk about having an edge though is what we will call an empirical edge. It is basically the sort of reasoning where we infer future results from past results. The same reasoning is utilized by both discretionary and system traders: however, their are unique differences that are relevant. The discretionary trader may assume markets to be random, the default belief system. However, as a result positive experiences eventually the trader eventually revises their belief system based on their performance. This forming a belief system based on the evidence is known as a statistical or empirical belief system. However, due to the non stationary nature of the market, empirical results are at best a soft edge. They are not conclusive: it is not the sort of mathematical edge that a casino has. Both discretionary traders and trading systems use empirical reasoning to form their basis. Discretionary traders primarily have formed their belief system on unseen data whereas systems are primarily developed historical data and verified on unseen data. Discretionary traders will probably be using more advanced or complex models of reality. A more complex model of reality is more likely to be real but also the performance of that model is less well understood. This means more variance and there are many unknowns for the discretionary trader (style drift, execution problems, market shifts). Systems rely on highly simplified models of reality that are less likely to be real. However, the parameters are well understood.

In other words, a discretionary trader will have difficulty producing super normal returns because they do not know how precise their predictions are. A system trader will have difficulty producing super normal returns because while they know how much they can leverage their system: the cost of that knowledge is having a less realistic model.

Expectancy is merely a descriptive statistic. If you are in a drawdown, at least from the highs, all the statistics will look bad. If you extrapolate anything from that it will show that you will continue to lose but if you are up then all the statistics will look good and any extrapolation will probably be more rosy then reality.

There are different ways of thinking about trading that are less discussed but may be illustrative. These ways of thinking about trading might be best described as "cognitive price discovery" and "intentionality". I suspect that elite level discretionary traders do not think in singular terms of having an edge, that is in terms of repeatable events, but rather incorporate also the sentiment of the other traders. Cognitive price discovery can be thought of as a real-time phenomena. As a hypothetical example, a trader may short a bunch of contracts at price lows, if new lows aren't made then the trader may infer from that that there is a large buyer at price lows and thus becomes a buyer him or herself.

As for say a system traders edge, we would need to differentiate the intentional conscious process that the system developer utilizes apart from the rules driven systems themselves. We can imagine a system trader, like a fiendish demon, working behind the scenes developing new systems, tweaking existing systems, retiring systems, etc. However, if this activity is responsible for the performance of the systems then we the cause of the profits is not the rules but rather the conscious decision making of the developer, the cognitive processes. In order to see the true rules driven performance, we would need to freeze the development and run the systems over a very long time such as 10 to 30 years. If the systems frozen 10-15 years back and ran 10-15 years in the future does not show an edge or as significant of an edge then we can infer that a system developers profits aren't coming exclusively (or perhaps even primarily) from the rules driven trades but rather from the cognitive processes that the developer employs, consciousness or in other words intentionality or cognitive processes.

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@kevinkdog Ive had a brief look at your AMA thread and you are primarily focused on algo systems. I don’t know much about your world so correct me if Im wrong but that requires a completely different mindset to day trading? You will have a variety of different strategies simultaneously working across multiple timeframes and instruments? You closely monitor expectancy and adjust your ‘worker bees’ when one underperforms? Expectancy is the single most important thing to you because it is the only way to gauge the performance across tens or hundreds of concurrently running algos?

I see now the importance of expectancy however as a day trader I just cannot accept that expectancy is at the top of my hierarchy of needs. Day trading requires that we constantly monitor ourselves and every possible direct and indirect variable that could affect our decision making ability. The food we eat, how much sleep we have had, what mood we are in, money mgmt, FOMO prevention etc..all contribute to how effectively we can execute our trade plan at go time. You can be amazing one day and the next day it’s all gone to shit because one of the parts where discipline slipped spiralled out of control causing a chain reaction. Think Jesse Livermore,

A day trader must monitor all aspects of themselves at all times just the same way that you monitor your algos expectancy at all times. In my world there is not one thing whos importance overrides all else. Expectancy will tell me how well Ive done to date but tomorrow is another day and if Im disciplined in all areas of my approach then I can maintain a positive expectancy.

--------------------------------------------------------------------------------------------------------------
For the benefit of anyone reading this, who like me was clueless to this very important metric (but thankfully am now fully aware of it), I have been doing some reading and the following is a basic intro on what you need to do. You should try and get as big a sample size as possible, a few hundred trades minimum if you can.

You only need 4 pieces of information:
1. number of winning trades
2. number of losing trades
3. amount of money won
4. Amount of money lost.

From this data we can calculate the following:

Net profit = amount of money won - amount of money lost
Win rate = number of winning trades / total number of trades
Lose rate = 1 - win rate
Average winner = amount of money won / total number of winners
Average loser = amount of money lost / total number of losers
Average reward / risk = average winner / average loser
Expectancy per trade = win rate x average winner – lose rate x average loser
Or, alternatively, expectancy per trade = net profit / total # trades
Expectancy per month (profit forecast) = expectancy per trade x average # trades per month
Expectancy per amount of money risked = win rate x (average reward / risk + 1) – 1
Or, alternatively, expectancy per amount of money risked = net profit / average loser / total # trades

Here is an example:
Lets assume we have been trading for 6 months and made a total of 540 trades. 297 of them were profitable and 243 were not, with $35.640,00 profit coming from the winning trades and $19.440,00 loss stemming from the losing trades. Lets make the calculations:


Net profit = $35.640,00 - $19.440,00 = $16.200,00
Win rate = 297 / 540 = 55%
Lose rate = 1 - 55% = 45%
Average winner = $35.640,00 / 297 = $120,00
Average loser = $19.440,00 / 243 = $80,00
Average reward / risk = $120,00 / $80,00 = 1,5
Expectancy per trade = 55% x $120,00 – 45% x $80,00 = $30,00
Or, alternatively, expectancy per trade = $16.200,00 / 540 = $30,00
In our example the expectancy per trade is $30,00. This means, on average (over many trades), each trade will contribute $30,00 to the overall P&L.

Expectancy per month = $30,00 x 540 / 6 = $2.700,00
In our example we can forecast a monthly profit of $2.700,00 based on prior performance.
Expectancy per $ 0.61% risked = 55% x (1,5 + 1) – 1 = 38%
Or, alternatively, expectancy per $ 0.61% risked = $16.200,00 / $80,00 / 540 = 0,38

Credit to JasperForex on tradingView for allowing me to reproduce the breakdown above.

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Grantx View Post
A day trader must monitor all aspects of themselves at all times; just the same way that you monitor your algorithm's expectancy at all times. In my world there is not one thing who's importance overrides all else. Expectancy will tell me how well I've done to date, but tomorrow is another day. If I'm disciplined in all areas of my approach then I can maintain a positive expectancy.

Numero Uno.

Great post, this is a good discussion for all of us.

For the record a good while back I did 2100% in 3 months with 177 discretionary five minute binary trades with a win rate of 67%, so I figure the expectancy was decent, maybe even 'super normal'. Then I blew it up because I went all experimental and failed completely on Numero Uno.

The two cannot be separated and I am still trying to recover from the divorce. Expectancy on its own means nothing if you are stupid with leverage or cannot control the inner forces.

Cheers

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Interesting to see, at the same time

1) how 'hot' this topic is
2) how difficult it is to 'articulate' what is the edge...

I think this is exactly what separates retail from professional world...
it would be worth a seminar and for sure more than a few hours can
be filled on this topic...

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rleplae View Post
Interesting to see, at the same time

1) how 'hot' this topic is
2) how difficult it is to 'articulate' what is the edge...

I think this is exactly what separates retail from professional world...
it would be worth a seminar and for sure more than a few hours can
be filled on this topic...

I agree. Well said.
Part of the issue is that edge and expectancy mean different things to different people, and in many cases aren't transferable.
To HFT it might be speed.
To Kevin it may be systems with high expectancy.
To a market maker or a prop customer desk it could be flow.
To somebody else it may be knowledge or information.
To yet somebody else fundamental analysis.
The list is endless.
The bottom line though is that unless you have a reason to believe you will make money, why would you do it?
That reason whatever it is, is your edge, however you define it.
Expanding on what somebody said earlier, if you dont know what your edge is, chances are you don't have one, which probably means you won't be trading long - at least not profitably.

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And, it should be noted that for many capital itself is an edge. Capital to deploy different types of strategies and even capital to trade in the first place. In fact, if we accept that capital is required to trade, we can logically see that no trader has ever made money exclusively from trading. A trader might say, for example, he doubled his 5k account. But where did the original 5k come from? Because capital is required to trade, we can see that at least a significant edge for all traders must have been acquiring some capital to start with. Basically, no one has ever made anything from trading ability alone: capital was required.

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tpredictor View Post
Let me add a different perspective to your question, first a hard "edge" would be something that is mathematically provable. Science is based on the idea that events are repeatable: it relies on a self-consistency assumption. If for whatever reason, things are different where I sit then where you sit, science itself would break down or more specifically, the scientific method would not yield useful results. A corollary to this idea that can be found in statistics is the normal distribution which many statistical methods assume or rely on to produce meaningful results. However, markets are non stationary which simply means that there are periods of both trend and range. Truthfully, markets are chaotic in nature. A different kind of mathematics would be required to elucidate any deeper truths.

As you eluded too, there are different types of edges in the market. If my trading cost are less then yours, I have a relative edge. That translates to my making more then you --even if we were to take the exact same trades: in some cases, that could even translate to my ability to consistently make money while you could be losing money.

What most traders talk about when they talk about having an edge though is what we will call an empirical edge. It is basically the sort of reasoning where we infer future results from past results. The same reasoning is utilized by both discretionary and system traders: however, their are unique differences that are relevant. The discretionary trader may assume markets to be random, the default belief system. However, as a result positive experiences eventually the trader eventually revises their belief system based on their performance. This forming a belief system based on the evidence is known as a statistical or empirical belief system. However, due to the non stationary nature of the market, empirical results are at best a soft edge. They are not conclusive: it is not the sort of mathematical edge that a casino has. Both discretionary traders and trading systems use empirical reasoning to form their basis. Discretionary traders primarily have formed their belief system on unseen data whereas systems are primarily developed historical data and verified on unseen data. Discretionary traders will probably be using more advanced or complex models of reality. A more complex model of reality is more likely to be real but also the performance of that model is less well understood. This means more variance and there are many unknowns for the discretionary trader (style drift, execution problems, market shifts). Systems rely on highly simplified models of reality that are less likely to be real. However, the parameters are well understood.

In other words, a discretionary trader will have difficulty producing super normal returns because they do not know how precise their predictions are. A system trader will have difficulty producing super normal returns because while they know how much they can leverage their system: the cost of that knowledge is having a less realistic model.

Expectancy is merely a descriptive statistic. If you are in a drawdown, at least from the highs, all the statistics will look bad. If you extrapolate anything from that it will show that you will continue to lose but if you are up then all the statistics will look good and any extrapolation will probably be more rosy then reality.

There are different ways of thinking about trading that are less discussed but may be illustrative. These ways of thinking about trading might be best described as "cognitive price discovery" and "intentionality". I suspect that elite level discretionary traders do not think in singular terms of having an edge, that is in terms of repeatable events, but rather incorporate also the sentiment of the other traders. Cognitive price discovery can be thought of as a real-time phenomena. As a hypothetical example, a trader may short a bunch of contracts at price lows, if new lows aren't made then the trader may infer from that that there is a large buyer at price lows and thus becomes a buyer him or herself.

As for say a system traders edge, we would need to differentiate the intentional conscious process that the system developer utilizes apart from the rules driven systems themselves. We can imagine a system trader, like a fiendish demon, working behind the scenes developing new systems, tweaking existing systems, retiring systems, etc. However, if this activity is responsible for the performance of the systems then we the cause of the profits is not the rules but rather the conscious decision making of the developer, the cognitive processes. In order to see the true rules driven performance, we would need to freeze the development and run the systems over a very long time such as 10 to 30 years. If the systems frozen 10-15 years back and ran 10-15 years in the future does not show an edge or as significant of an edge then we can infer that a system developers profits aren't coming exclusively (or perhaps even primarily) from the rules driven trades but rather from the cognitive processes that the developer employs, consciousness or in other words intentionality or cognitive processes.

What a great post!

You have summed up the core challenges in successful trading. The markets are constantly evolving and therefore constant adaption is required, here lies the problem with the rigid rules usually found in Charting and TA (Systems Trading). Price doesn't always reflect the true nature of the market, so where is the reliable edge in Price Analysis?

We all trade a system even if it is as chaotic as flipping a coin. If you are constantly adapting your system (hourly/daily because this is how quickly the core market dynamic changes) to suit market dynamics then you are a Discretionary Trade.r As a successful Discretionary Trader my observations are quantified thru spreadsheet formulas and analysis, so there is a technical aspect but that takes second place to getting and staying as close to the market leading edge as possible.

The nature of the market itself, not the system must dictate what we do.

Cheers John

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Grantx View Post
@kevinkdog

I see now the importance of expectancy however as a day trader I just cannot accept that expectancy is at the top of my hierarchy of needs.

Here's my point: regardless of your style of trading, if you don't have a way(s) of entry and exit that over the long haul produces profit, nothing else matters - you will lose.

Too many people think journaling, or money management, or psychology, etc. is the key to making them profitable. Not true!

Think of it like roulette. Many people invent money management schemes, record past data, journal their thoughts on how to win, etc. And you know what? They still all lose in the long run. Why? Because they are playing a negative expectancy game - the odds are not in their favor.

That is why I put expectancy at the top of the list. If your trading method - whatever it is - does not have a long term positive expectancy, then all those other things do not matter. Having all those other things may help you lose money more slowly, but you will still lose money in the long run.

The ironic (and confusing) part of this is that even if you do have a long term positive expectancy method, bad/lack of money management, psychology, etc can still make you a loser. It is like this:

Negative expectancy trading method, Poor psychology, money management, discipline : You LOSE
Negative expectancy trading method, Excellent psychology, money management, discipline : You LOSE
Positive expectancy trading method, Poor psychology, money management, discipline : You LOSE
Positive expectancy trading method, Excellent psychology, money management, discipline : You WIN


I hope this clarifies it.


By the way, the expectancy description was good, but way too complicated.

Simple:

Expectancy = Average Trade


(Van Tharp also has an expectancy I call "Tharp Expectancy" = avg trade/avg losing trade)

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kevinkdog View Post
Negative expectancy trading method, Poor psychology, money management, discipline : You LOSE
Negative expectancy trading method, Excellent psychology, money management, discipline : You LOSE
Positive expectancy trading method, Poor psychology, money management, discipline : You LOSE
Positive expectancy trading method, Excellent psychology, money management, discipline : You WIN

We all most definitely agree on the two components.

The only difference is that system/professional guys start the sentence with expectancy, and assume that psychology is a given, otherwise they would be in a different job; whereas any of us mere retail traders that have a decent amount of experience start the sentence with psychology, knowing that if we don't crack that we aren't going to find any expectancy anyway.

Anybody else starting out has to discover the hard way that both worlds are inhospitable places to live in.

Cheers

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ratfink View Post
We all most definitely agree on the two components.

The only difference is that system/professional guys start the sentence with expectancy, and assume that psychology is a given, otherwise they would be in a different job; whereas any of us mere retail traders that have a decent amount of experience start the sentence with psychology, knowing that if we don't crack that we aren't going to find any expectancy anyway.

Anybody else starting out has to discover the hard way that both worlds are inhospitable places to live in.

Cheers

I definitely agree that both are needed to succeed!

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tpredictor View Post
And, it should be noted that for many capital itself is an edge. Capital to deploy different types of strategies and even capital to trade in the first place. In fact, if we accept that capital is required to trade, we can logically see that no trader has ever made money exclusively from trading. A trader might say, for example, he doubled his 5k account. But where did the original 5k come from? Because capital is required to trade, we can see that at least a significant edge for all traders must have been acquiring some capital to start with. Basically, no one has ever made anything from trading ability alone: capital was required.


I don't think you can consider capital in itself an edge, however, how you acquired your capital may potentially give you a solid foundation to be a trader. If you had a successful business, career, etc. You may have acquired skills that may help you in trading. Any success requires a certain level of struggle, persistence, setbacks, problem-solving skills, etc. Those who bring it to the trading world could potentially handle setbacks better, and every trader will face setbacks.

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kevinkdog View Post
Negative expectancy trading method, Excellent psychology, money management, discipline : You LOSE

By the way, the expectancy description was good, but way too complicated.

Simple:

Expectancy = Average Trade

I put the cart before the horse spending a lot of time reading books on trading psychology and a couple of home study courses. Very interesting and I don't regret any of it as I feel it has been very beneficial for me as a person. But I feel it is similar to performance coaching for a sportsman which is done to enhance results and is best worked on after the basic techniques and abilities have become almost subconcious. I spent too much time on 'increasing performance' with out having the foundation of a valid trading methodology to build upon.

And I agree about expectancy. After looking at expectancy formulas that all seemed to differ from Van Tharp's in varying degrees of complexity I also just use the average trade. If after 100 contracts/Round Turns traded I have made $1,000 I see my expectancy as $10/Round Turn.

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ratfink View Post
The only difference is that system/professional guys start the sentence with expectancy, and assume that psychology is a given, otherwise they would be in a different job; whereas any of us mere retail traders that have a decent amount of experience start the sentence with psychology, knowing that if we don't crack that we aren't going to find any expectancy anyway.

Well said

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Let me summarize why I think might be why there are different views of expectancy. If you trade a system, trades are generated based on a consistent set of rules and taken in a consistent way. As such, expectancy is used both as as the predictive statistic (an extrapolation of what the future will look like) and as a descriptive statistic of the past (what actually happened).

However, attempting to trade like a system for a discretionary trader would be both nearly impossible and also nonsensical because to do that you would need to generate your fixed set of rules and then you would need to trade them in exactly the same way with no variance. If you were to do both of those activities though, you are now just trading a system and there is no longer any discretionary component. As such, expectancy takes on a different meaning for the discretionary trader. The rules are no longer fixed: so it is not a validation of the rules but rather of the cognition of the trader. As many more factors can effect cognition, those other factors can become more relevant. However, market cognition is still probably a better place to invest your energies then in general psychology.

Mathematically, it is known that models with more variables are more likely to capture complex phenomena like markets exhibit. However, introducing more variables, into traditional systems most often results in two problems (1) inability to understand the model and (2) over-fitting. We know that the discretionary trader's model should be more complex. As such, if the discretionary trader sees a verifiable truth in markets (such as markets trend or markets trade in a range) then they assume that they are trading closer to reality. A method closer to reality is more likely to be robust. It is more likely to capture the truth of the markets. The cost for trading a more realistic method though, a more robust method, is that it becomes more difficult to bound the strategy at the extents. This translates into not knowing how much to bet and not having as much clarity into the model. Simplifying the model to produce a consistent set of rules, will produce a characterization of reality but the benefit is that we know exactly how the model behaved in the past. We can now gain insight into how the strategy is working and, at least, we can figure out under given scenarios the historical risks of betting varying amounts. Unfortunately, the cost is that because the model has been simplified, the model may not work as well going forward and while we know our historical estimates of risk: they could be wrong. Ironically, most discretionary traders focus on consistency but rationally we should expect both greater variance in discretionary trading and enhanced robustness. On the other hand, we should expect trading systems to exhibit greater consistency but higher rates of failure.

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tpredictor View Post
Let me summarize why I think might be why there are different views of expectancy. If you trade a system, trades are generated based on a consistent set of rules and taken in a consistent way. As such, expectancy is used both as as the predictive statistic (an extrapolation of what the future will look like) and as a descriptive statistic of the past (what actually happened).

However, attempting to trade like a system for a discretionary trader would be both nearly impossible and also nonsensical because to do that you would need to generate your fixed set of rules and then you would need to trade them in exactly the same way with no variance. If you were to do both of those activities though, you are now just trading a system and there is no longer any discretionary component. As such, expectancy takes on a different meaning for the discretionary trader. The rules are no longer fixed: so it is not a validation of the rules but rather of the cognition of the trader. As many more factors can effect cognition, those other factors can become more relevant. However, market cognition is still probably a better place to invest your energies then in general psychology.

Mathematically, it is known that models with more variables are more likely to capture complex phenomena like markets exhibit. However, introducing more variables, into traditional systems most often results in two problems (1) inability to understand the model and (2) over-fitting. We know that the discretionary trader's model should be more complex. As such, if the discretionary trader sees a verifiable truth in markets (such as markets trend or markets trade in a range) then they assume that they are trading closer to reality. A method closer to reality is more likely to be robust. It is more likely to capture the truth of the markets. The cost for trading a more realistic method though, a more robust method, is that it becomes more difficult to bound the strategy at the extents. This translates into not knowing how much to bet and not having as much clarity into the model. Simplifying the model to produce a consistent set of rules, will produce a characterization of reality but the benefit is that we know exactly how the model behaved in the past. We can now gain insight into how the strategy is working and, at least, we can figure out under given scenarios the historical risks of betting varying amounts. Unfortunately, the cost is that because the model has been simplified, the model may not work as well going forward and while we know our historical estimates of risk: they could be wrong. Ironically, most discretionary traders focus on consistency but rationally we should expect both greater variance in discretionary trading and enhanced robustness. On the other hand, we should expect trading systems to exhibit greater consistency but higher rates of failure.


Another excellent post defining trading reality, clearly you have been to the mountain.

The nature of markets regularly change sometimes in minutes, but definately in hours and days, requiring constant adaption. Rigid systems are almost impossible to capture these constant changes effectively.

All that is required is to accurately define the nature of the market at any given moment and to be positioned in that direction. Pretty simple really.

I think in ranges to enter and changes in market bias to exit or reverse. I don't try to force my will onto the market with fixed stops, profit targets ect, I will just get run over. How much of my working capital do I risk, this depends on what I am seeing unfolding and sometimes just how confident I am feeling on the day, yes we all fluctuate, we are human not machines, why try to be what we are not, focus on being good at what you are. I view working capital as a float that I am prepared to lose in a worst case scenario (10-20% of my account) , that way I am not trading scared, it is already gone and is a bonus when I keep it, which is most of the time.

Trading is an art form not a science, to me systems trading is the equivalent of finger painting.

I have been in the game a long time, the only people that I know personally who have consistently made a living from trading generally have quite similar views. I don't personally know any Chartists/Technitians that have succeeded long term, perhaps there are some, but generally it seems to be the domain of the learner mug punter, don't worry we have all been there at one time or another, there is hope. Adapt or fail!

Don't be baffled by the b-llsh-t, get the basics right and the rest will follow.

Good Hunting.

Cheers John

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Johno1 View Post

Trading is an art form not a science, to me systems trading is the equivalent of finger painting.

I have been in the game a long time, the only people that I know personally who have consistently made a living from trading generally have quite similar views.

Different (paint) strokes for different folks, I suppose.

I have the exact opposite experience - I know quite a few successful "finger painting" traders, but zero long term successful discretionary traders (I'm not saying they don't exist though, and I'd never put down what the successful ones do)...

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kevinkdog View Post

Expectancy = Average Trade


(Van Tharp also has an expectancy I call "Tharp Expectancy" = avg trade/avg losing trade)

Would you mind explaining the best way of calculating expectancy? avg trade/avg losing trade doesnt factor in how much was risked per trade and according to The Van Tharpe website this needs to be part of the calculation.

Van Tharpe expectancy

TIA.

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Grantx View Post
Would you mind explaining the best way of calculating expectancy? avg trade/avg losing trade doesnt factor in how much was risked per trade and according to The Van Tharpe website this needs to be part of the calculation.

Van Tharpe expectancy

TIA.

It is easy.


What most people call "expectancy" is just average trade value (#1 in both screenshots below)

Van Tharp also has something that is a risk adjusted expectancy, I call it Tharp Expectancy. It is #1 /(-#2) Tharp has made it confusing, because he changed his definition of Expectancy at one point.

In his calculation, he is considering risk to be, on average, the amount of an average losing trade. That can be debated, but that is what his calculation uses.




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