# Defining expectancy: KISS or Rocket Science? Which do you prefer and why?



## cynic (15 December 2015)

Recently I happened to derail a thread whilst discussing the topic of positive expectancy.

Given that one of my pet hates is the tendency of experts to overcomplicate the simplest of concepts by impressing the importance of superfluous mathematical operations, thereby causing needless confusion to market newcomers, I decided that this topic warrants a thread of its very own.

Those acquainted with my various posts will probably already be aware that I tend to take a macroscopic/quantitive approach to measurement of overall system performance, and prefer to avoid excessive degrees of analytical dissection.

As such aggregate calculations often amply serve my needs.

I do understand that ,depending upon one's methodology, some additional component measures may indeed be useful.

 My concern with trading, like so many of life's endeavours, is that it starts to become a religion where people become so attached to specific rituals and doctrine that they not only lose sight of the original purpose and intent, they also at times become zealous to the point of fanaticism.

I'd be interested to hear others' thoughts on this topic and, should this thread progress,, intend to share a few anecdotes of my encounters with newcomers whom I believe were effectively sabotaged by the religious zealotry of various market gurus.


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## Gringotts Bank (15 December 2015)

*Re: Defining expectancy : KISS or Rocket Science? Which do you prefer and why?*



cynic said:


> I'd be interested to hear others' thoughts on this topic and, should this thread progress,, intend to share a few anecdotes of my encounters with newcomers whom I believe were effectively sabotaged by the religious zealotry of various market gurus.




People *love *to over-complicate stuff, and not just in trading.  

It's an attempt to achieve one or more of the following goals:

1. bamboozle the reader into thinking you're smart/prestigious

2. achieve distance so that those _not_ in the loop don't come to understand that you are making a killing doing something very simple.  eg. mechanics, lawyers.

3. create a cool 'inner circle' with heirachical structure, as a way of fulfilling narcissistic supply (eg. Scientology, many religions and corporations/organizations).


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## cynic (15 December 2015)

*Re: Defining expectancy : KISS or Rocket Science? Which do you prefer and why?*

Yes! I 've certainly observed all those things you mention. 

During a recent phone discussion with a friend seeking guidance in developing his personal trading system/method, I was startled when he disclosed that he'd encountered material that impressed the need for achieving a certain minimum RR ratio as though this was some sort of infallible and incontestable truth. I immediately responded by offering some hypothetical counterexamples that highlighted the concept of positive expectancy whilst at the same time alerting him to certain fallacious claims regarding the scope and intent of the RR ratio.


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## Gringotts Bank (15 December 2015)

*Re: Defining expectancy : KISS or Rocket Science? Which do you prefer and why?*



cynic said:


> Yes! I 've certainly observed all those things you mention.
> 
> During a recent phone discussion with a friend seeking guidance in developing his personal trading system/method, I was startled when he disclosed that he'd encountered material that impressed the need for achieving a certain minimum RR ratio as though this was some sort of infallible and incontestable truth. I immediately responded by offering some hypothetical counterexamples that highlighted the concept of positive expectancy whilst at the same time alerting him to certain fallacious claims regarding the scope and intent of the RR ratio.




I don't use price stops so RR is something I don't calculate in my systems. 

What sort of examples did you use?


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## fraa (15 December 2015)

*Re: Defining expectancy : KISS or Rocket Science? Which do you prefer and why?*

I am only starting out and still reading atm - but I thought the principles of expectancy was articulated well here

https://www.thechartist.com.au/images/stories/Trish/Successful Stock Trading by Nick Radge.pdf

This is the 1st section of Nick Radge's book Adaptive Analysis which was highlighted here as being an essential read re basics of expectancy and money management.

Does he miss anything ?


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## cynic (15 December 2015)

*Re: Defining expectancy : KISS or Rocket Science? Which do you prefer and why? of*



fraa said:


> I am only starting out and still reading atm - but I thought the principles of expectancy was articulated well here
> 
> https://www.thechartist.com.au/images/stories/Trish/Successful Stock Trading by Nick Radge.pdf
> 
> ...




It just so happened that I read the first chapter of that particular book a couple of months ago. I found the content largely agreeable. Point 4 in his summary at the end of chapter 1, pretty much sums it all up for me:

"The amount you win when you win versus the amount you lose when you lose is more important than trying to be right."


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## cynic (15 December 2015)

*Re: Defining expectancy : KISS or Rocket Science? Which do you prefer and why?*



Gringotts Bank said:


> I don't use price stops so RR is something I don't calculate in my systems.
> 
> What sort of examples did you use?




I simply gave two hypothetical extremes, one involving overall profit with a particularly high win rate where profit targets were considerably smaller than stop losses.

The other was pretty much the opposite. Larger profit targets, tighter stops ,and a win rate sufficiently low to ensure the example demonstrated the potential for failure to profit from adherence to the "golden rule"


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## Quant (15 December 2015)

Feel a bit like the Christian entering the colosseum   ,  I feel this is directed at me to a degree and I comment in here with trepidation 

I like simplistic but not simple , lets get that out the way 

Perry Kaufman a well respected trader / educator was a rocket scientist for NASA  

Anecdotes prove nothing , only facts and statistics do . Statistics help uncover facts , well at least probabilities . Which are what a trader needs to define/find his edge  .

Now expectancy without the 2 inputs is fine in a crude way 'but' using the 2 inputs of trade success rates and risk/reward we can define the sweet spot in the ratio to get the best results without flying blind and putting ourselves in harms way unwittingly 

Firstly I will address trade win %age , unqualified to most traders this stat has bearing on drawdown (referred as  DD from her on) potentials , the lower the trade %age the higher the probability of multi consecutive losing trades . Now what is the result of having 10 consecutive losing trades , it will be detrimental to DD , now this DD will be dependant on the risk taken each trade , if you risk 2% you will near a 20% DD , did you know that with a 30% trade win rate the chances of 10 consec losers in 50 trades is 70% in a 50 trade period . Now its a given that with a low % WR ( win rate ) that risk reward will be ( well should be ) better than a system with a 70% win rate .

You know what , I cant be bothered writing an essay ( so will stop now ) to demonstrate a point of view that will be dismissed ( in all likelyhood with one line )  . I will resume this with a copy and paste or link that is parallel to my thinking once I find one   ...

probability table  vvvvvvvvvvvvv  





This is a start but I will find something with a more complete analysis 

http://forexiation.blogspot.com.au/2013/02/relationship-between-drawdown-and-risk.html


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## cynic (15 December 2015)

Thanks, for contributing to this thread quant. We are certainly of different philosophies in some respects, (but thankfully not in all). I have  no complaint with others using the method that they consider most suited to their chosen market and personal resources.

 It just so happened that I'd been stewing on the problem of some newcomers latching onto specific advice regarding minimum RR a week ago and our discourse in the other thread just happened to reignite my concern over "absolute" or "golden" rules. 
It is not intended to be a direct attack on anyone on this forum (although I  do consider it partially a redress to comments made regarding there being only one correct way to do certain things.)

I apologise for having been unnecessarily abrasive in my response to yourself and your offerings, my friends sometimes tell me that I  have aĺl the subtlety of a flying brick!


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## Gringotts Bank (15 December 2015)

*Re: Defining expectancy : KISS or Rocket Science? Which do you prefer and why?*



cynic said:


> I simply gave two hypothetical extremes, one involving overall profit with a particularly high win rate where profit targets were considerably smaller than stop losses.
> 
> The other was pretty much the opposite. Larger profit targets, tighter stops ,and a win rate sufficiently low to ensure the example demonstrated the potential for failure to profit from adherence to the "golden rule"




Seems reasonable.  Are you saying he dismissed these ideas in favour of his rigid RR rules?


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## Quant (15 December 2015)

*Re: Defining expectancy : KISS or Rocket Science? Which do you prefer and why?*



Gringotts Bank said:


> People *love *to over-complicate stuff, and not just in trading.
> 
> It's an attempt to achieve one or more of the following goals:
> 
> ...




Seriously  ?????    Take a good hard long look in the mirror , this passes as objective commentary ??  

I might be in the wrong place  , feels like facebook


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## Gringotts Bank (15 December 2015)

*Re: Defining expectancy : KISS or Rocket Science? Which do you prefer and why?*



Quant said:


> Seriously  ?????    Take a good hard long look in the mirror , this passes as objective commentary ??
> 
> I might be in the wrong place  , feels like facebook




Don't take it personally, it wasn't directed at you.  But if the shoe fits...


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## Quant (15 December 2015)

*Re: Defining expectancy : KISS or Rocket Science? Which do you prefer and why?*



Gringotts Bank said:


> Don't take it personally, it wasn't directed at you.  But if the shoe fits...




Don't worry I wasn't taking it personally , but maybe you should  ....


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## Gringotts Bank (15 December 2015)

*Re: Defining expectancy : KISS or Rocket Science? Which do you prefer and why?*



Quant said:


> Don't worry I wasn't taking it personally , but maybe you should  ....




It's *obvious *you took it personally.  The question is why??

I was responding to cynic's post of the same tone and it had *nothing to do with you or anyone on ASF.*


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## Joe Blow (15 December 2015)

Before this situation gets any worse, can I please request that everyone stick to discussing the topic at hand without making things personal?

I hate to see threads derailed and bad blood between ASF members over a minor disagreement.


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## Quant (15 December 2015)

Joe Blow said:


> Before this situation gets any worse, can I please request that everyone stick to discussing the topic at hand without making things personal?
> 
> I hate to see threads derailed and bad blood between ASF members over a minor disagreement.




Joe I felt like I was invited into a conversation through a door where I had to walk through a path of protangonists armed with baseball bats , silly thinking by me I went through the door , I might be new but i'm the one that's not feeling welcome and I don think ive gone out of my way to antagonize anyone , quite contrary in fact ... feel free to ban me as I am not the one who has let this standard be the norm , I am here with good will and that certainly cant be said for some of the main players here , I am not trying to make waves but again on  the other hand I am not submissive  ... your call


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## Gringotts Bank (15 December 2015)

In fact when I read your post quant, my thought was as follows:  "Here's an example of complexity without unecessary over-complicating".  

I'm sure you've noticed many times (and many professions) where my original post holds true.

Forums are a hard place to communicate, especially if you think others are out to get you.  They aren't.


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## Joe Blow (15 December 2015)

Quant said:


> Joe I felt like I was invited into a conversation through a door where I had to walk through a path of protangonists armed with baseball bats , silly thinking by me I went through the door , I might be new but i'm the one that's not feeling welcome and I don think ive gone out of my way to antagonize anyone , quite contrary in fact ... feel free to ban me as I am not the one who has let this standard be the norm , I am here with good will and that certainly cant be said for some of the main players here , I am not trying to make waves but again on  the other hand I am not submissive  ... your call




I always hope that it is possible for forum members to disagree about concepts, ideas and methodologies in a constructive way while still being polite and respectful to others. However, sometimes things can get a little testy, mostly due to misunderstandings or personality clashes.

I think that GB has made some broad generalisations that have not helped the discussion, and has been a little antagonistic. The question is, where do we go from here? I would hope that everyone concerned can de-escalate the situation and we can get the thread back on track.

It is impossible to avoid disagreement. I just hope that when people do disagree it can be done in a constructive rather than a destructive way. In this particular situation I hope that the hatchet can be buried and everyone can move on for the sake of the discussion.


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## cynic (15 December 2015)

*Re: Defining expectancy : KISS or Rocket Science? Which do you prefer and why?*



Gringotts Bank said:


> Seems reasonable.  Are you saying he dismissed these ideas in favour of his rigid RR rules?




Fortunately he was still in the questioning phase of his search and given his acumen, I  suspect he would have quickly recognized the logical flaw in the information in his own time.

Others that Ive encountered in the past weren't as fortunate. Some had developed such unshakeable faith in their chosen guru that they were quite simply unable to contemplate any concepts/perspectives to the contrary.

That's not to say that RR and related measures aren't useful when applied within an appropriate context ,with due regard to scope and limitations, it just frustrates me that I  have to explain so much more than might otherwise be necessary when attempting to convey one of the most important and simple concepts of trading to others.

P.S.  A big thankyou to all contributors to this thread so far. Given that I do not want this thread to become too onesided, I'd  like to encourage those, whom like quant, have an appreciation for the application of statistical approaches to formulation and management of their trading to freely contribute their perspective and experience.


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## cynic (15 December 2015)

Quant said:


> Joe I felt like I was invited into a conversation through a door where I had to walk through a path of protangonists armed with baseball bats , silly thinking by me I went through the door , I might be new but i'm the one that's not feeling welcome and I don think ive gone out of my way to antagonize anyone , quite contrary in fact ... feel free to ban me as I am not the one who has let this standard be the norm , I am here with good will and that certainly cant be said for some of the main players here , I am not trying to make waves but again on  the other hand I am not submissive  ... your call




Again my sincere apologies quant. I was both delighted and impressed by your willingness to participate in this thread, particularly given the difference in our trading philosophies. GB and I  do happen to share certain controversial perspectives on life in general and although disagreeable views have bÃ¨en expressed, I remain hopeful that they were originally intended to be nothing more than general observations drawn largely from life experiences outside of this forum rather than personal attacks on specific members.


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## Gringotts Bank (15 December 2015)

*Re: Defining expectancy : KISS or Rocket Science? Which do you prefer and why?*



cynic said:


> Fortunately he was still in the questioning phase of his search and given his acumen, I  suspect he would have quickly recognized the logical flaw in the information in his own time.
> 
> Others that Ive encountered in the past weren't as fortunate. Some had developed such unshakeable faith in their chosen guru that they were quite simply unable to contemplate any concepts/perspectives to the contrary.
> 
> ...




The thing about gurus is that they afford you the _other _type of expectancy (psychological expectancy).  As strange as it sounds, I know of situations where I consider this worth paying for.  If a guru has a rock solid belief in his [statistically useless] approach, and can convey that belief to his followers, the followers should in theory trade much better.  This is because fear has been removed from the decision-making process.  I could dig up some scientific papers on fear and decision making in finance if anyone is interested.

So, if you compared two groups:

1) guru backing, high ++ psychological expectancy with random entries on random stocks, choose your own exits

2) random entries on random stocks, choose your own exits

...and then compared the returns on each, I'd be very confident group 1 would outperform group 2.


All this is aside from statistical expectancy; a different topic.


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## cynic (15 December 2015)

*Re: Defining expectancy : KISS or Rocket Science? Which do you prefer and why?*



Gringotts Bank said:


> The thing about gurus is that they afford you the _other _type of expectancy (psychological expectancy).  As strange as it sounds, I know of situations where I consider this worth paying for.  If a guru has a rock solid belief in his statistically useless approach, and can convey that belief to his followers, the followers should in theory trade much better because fear has been removed.
> 
> So, if you compared two groups:
> 
> ...




That's  a very interesting perspective. Ive often noticed that some traders ascribe so much importance to their setup they fail to notice just how often the risk management of the trade turns out to be the determining factor. For example if the market can only move up or down and the direction of the next move is theoretically uncertain, and the trader's Strike rate happens to be only sufficiently high to accommodate 1 unit of risk for every 3 units of reward, (i.e.win rate marginally above 25%) then one wonders whether an RR of 1 to 1 combined with faith in a dartboard might not prove similarly effective?


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## systematic (15 December 2015)

I'll ignore all comments and just respond to the OP like this:

I'll cast my preference as KISS not rocket science.
I come from a (long forgotten) background where expectancy can be defined accurately*.  The market is not such a place.  
As a long(er) term trader (some call that 'investor,' but whatever), I barely think in terms of expectancy.  In the real world, traders learn to think in terms of expectancy because they often have stops, or have read Van Tharp and think in terms of risk multiples etc.  
I look at all kinds of stats.  All of them are only so useful (yet I love them all). 
But for a different perspective for this thread, expectancy is not something I even really think about.  I just don't need to.





*In a misspent youth.  For any newbie reading.  Don't be daunted by any of this.  Expectancy in a fixed system is as simple as the old example:

If you and I were to play a coin toss game, and I gave you $1.10 for every time you bet $1.00 on heads (and won) and $1.00 for every time you bet on tails (and won); well for a start you should only bet on heads.
Half of the time you'll outlay $1.00 and win $1.10; the other half of the time you'll lose a dollar.  
The outcome over 200 bets therefore, is that you'll:
- outlay $200 on 200 individual, $1.00 bets
- you'll lose 100 of the bets (heads or tails, remember)...so you'll lose $100 on those, right?
- you'll win 100 of the bets (heads)...and because I'm paying you $1.10 for each heads...you've just made $110
- The $110 you made on heads minus the $100 you lost on tails , leaves you with what? $10 bucks.
- You have a $10 profit from 200, $1.00 bets
- So; you made $0.05 (5 cents) a bet, right?  $10 profit, divided by 200 bets, equals 5 cents per bet.
- You are making 5 cents a bet per $1 bet.  
- That's 5% (5 cents, divided by 100 cents)
- You have a 5% expectancy

Congrats; you are now officially a quant!

Newbie; (I say newbie, because I don't want to insult anyonen else!)...this is why you shoudn't play the pokies.  Same thing, only in the house's favour (and more than 5%)

For many investors (yes, I'm being somewhat diplomatic, there) - that's about all you need to understand about expectancy.  You have one, that's for sure.  You just want it to be positive (the coin toss game), and not negative (the pokies).




...Mine is only one perspective.  Others may validly place more importance on it.


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## Quant (15 December 2015)

systematic said:


> I'll ignore all comments and just respond to the OP like this:
> 
> I'll cast my preference as KISS not rocket science.
> I come from a (long forgotten) background where expectancy can be defined accurately*.  The market is not such a place.
> ...




It goes without saying if you have no edge you have no positive expectancy  , its a gamble 

Edge is a slippery slope as well for many think they have an edge but they have no statistical proof 

Guessing is what many traders do with a lot of these stats as  it is hard work defining real probabilities and Risk/reward , truth be known those with a static system are just biding time till it all unravels ...

The only systems traders that have a system that stands the test of time have developed intuitive models that are way beyond the realm of 99% of traders and that's being kind , years involved in development of said systems

Data miners will never achieve a thinking system , its the world of a price action trader that can mathematize price action 

True experienced price action traders with a great head for maths and a penchant for coding are the eligible participants ... a rare combination indeed 

A lot of tenacity required and some serious cognitive ability required , Kiss is great but if you want to be elite you need to think like a rocket scientist , its nothing but a choice  albeit one to not take lightly


PS I don't need to be right I just want the money


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## craft (15 December 2015)

Quant said:


> It goes without saying if you have no edge you have no positive expectancy  , its a gamble
> 
> Edge is a slippery slope as well for many think they have an edge but they have no statistical proof
> 
> ...




Quant, can you define edge (in a trading sense)?


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## cynic (15 December 2015)

systematic said:


> I'll ignore all comments and just respond to the OP like this:
> 
> I'll cast my preference as KISS not rocket science.
> ...
> ...




Many thanks for your input systematic. It sounds like you've arrived at that enviable pinnacle of certainty regarding your trading outcomes.

In addition to your great expectancy example, I was also impressed with the generosity of your last statement which readily allows a space for those holding alternative viewpoints.


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## Quant (15 December 2015)

craft said:


> Quant, can you define edge (in a trading sense)?




Edge = advantage  , in my case proven ( in my eyes ) mathematically back and forward tested . Ultimately the true test of a trader is the curve of P&L


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## galumay (15 December 2015)

Quant said:


> It goes without saying if you have no edge you have no positive expectancy  , its a gamble




Mmm...thats a wildly sweeping 'absolute' - stated with certainty (which always makes things look more convincing!)

Traders and those of a technical bent often seem well able to convince them selves they have an 'edge'.

I am more like craft in this philosophical difference of opinion - no real use for the concept of 'positive expectancy', but then I am not sure many long term investors would. 

There is something to be pondered about the strength of human ambition to find absolutes where its likely few exist.


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## Quant (15 December 2015)

galumay said:


> Mmm...thats a wildly sweeping 'absolute' - stated with certainty (which always makes things look more convincing!)
> 
> Traders and those of a technical bent often seem well able to convince them selves they have an 'edge'.
> 
> ...





Lets not confuse positive expectancy with an absolute , an edge is a statistical advantage not a guarentee


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## minwa (15 December 2015)

Quant said:


> Edge is a slippery slope as well for many think they have an edge but they have no statistical proof




Quant I notice you use a lot of diagonal drawn trendlines but you sound like a very mechanically rules trader. How do you incorporate the trendlines which is open to different interpretation into your statistics of testing ?


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## craft (15 December 2015)

Quant said:


> Edge = advantage




Ok so define advantage (in a trading sense)




Quant said:


> Ultimately the true test of a trader is the curve of P&L





Now see that is what I think cynic is saying. the ultimate test is profit. (achieved over enough occurrences to eliminate the impact of randomness)

but I also agree that the strike rate (win/loss ratio or whatever you want to call it) component when you break profit down into expectancy is important for position sizing and risk of ruin.

ps

enjoyed your post too systematic. ASF could do with a thanks or thumbs up button to make showing appreciation easier I reckon.


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## cynic (15 December 2015)

galumay said:


> ...
> There is something to be pondered about the strength of human ambition to find absolutes where its likely few exist.




I largely agree. I  suspect that mankind's desire for certainty arises from insecurity and fear of the uncertain/unknown. Hence the commonplace insistence by some in having possession of an infallible and immutable truth/certainty. For such individuals, acceptance that their infallible belief might actually be subjective, rather than absolute, or perhaps even totally wrong, is too scary for some to contemplate as it would require embracing uncertainty and aÃ§cepting the uncomfortably fearful state of once again being confronted by a world of the uncertain/unknown.

An illusory sense of control is so much more comforting to some than the reality of powerlessness within one's environment.


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## Quant (15 December 2015)

minwa said:


> Quant I notice you use a lot of diagonal drawn trendlines but you sound like a very mechanically rules trader. How do you incorporate the trendlines which is open to different interpretation into your statistics of testing ?





Does anyone else get so many questions in their first 2 days   ;-)   ...  I draw my charts for public display in a price action style that has served me well for over a decade and in the main they do reflect what you will see in my algo charts ' but ' if I posted my algo charts almost  #1 no-one would makes sense of it #2 id get asked 10 times more questions than I do #3 my algo charts are my IP and I am not keen to give anyone the chance to reverse engineer basically what has taken me the best part of 5 years to evolve 

trendlines are reflected in my algo with trend filters amongst other things , my algo is mechanical but not automated  ..... yet

PS  ..  hint trends are a series of higher or lower swings , that part is easily coded  ..


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## fraa (15 December 2015)

Without rules (absolutes ?) to structure the unknown, you will have nothing to guide your action and so you cannot "act" (excluding that not acting can be a conscious decision). You have to have something - otherwise there is no thought and you might as well go two face and flip a coin.


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## Quant (16 December 2015)

fraa said:


> Without rules (absolutes ?) to structure the unknown, you will have nothing to guide your action and so you cannot "act" (excluding that not acting can be a conscious decision). You have to have something - otherwise there is no thought and you might as well go two face and flip a coin.




Seriously lets not twist words , challenge you to find a definition of rules that includes absolutes .... my rules are filters ... nothing more , a combination of filters will come up with a result that will give a statistical edge if you follow the result , nothing more & nothing less . Is it that hard of a concept to follow ...  lets not make it something it is'nt


 I am not answering any more questions today .....

the concept of an algo is a flow charts with a series of questions asked that alter the path , that's the easy part ..... its the questions that are the difficult part  

lets leave it there   ......   Google is an option , go explore


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## cynic (16 December 2015)

Quant said:


> Does anyone else get so many questions in their first 2 days   ;-)   ...  I draw my charts for public display in a price action style that has served me well for over a decade and in the main they do reflect what you will see in my algo charts ' but ' if I posted my algo charts almost  #1 no-one would makes sense of it #2 id get asked 10 times more questions than I do #3 my algo charts are my IP and I am not keen to give anyone the chance to reverse engineer basically what has taken me the best part of 5 years to evolve
> 
> trendlines are reflected in my algo with trend filters amongst other things , my algo is mechanical but not automated  ..... yet
> 
> PS  ..  hint trends are a series of higher or lower swings , that part is easily coded  ..




I can recall at least a couple of enthusiastic members of this forum also being initiated with something akin to a baptism in blood and fire. Those members were understandably uncomfortable with their reception at the time, but the community consequently warmed to them a lot more quickly on those occasions.


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## systematic (16 December 2015)

craft said:


> ASF could do with a thanks or thumbs up button to make showing appreciation easier I reckon.




...Totally true; I was looking for the, 'like' button on your post, at the same time.


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## cynic (16 December 2015)

fraa said:


> Without rules (absolutes ?) to structure the unknown, you will have nothing to guide your action and so you cannot "act" (excluding that not acting can be a conscious decision). You have to have something - otherwise there is no thought and you might as well go two face and flip a coin.




A very good friend of mine improved his trading performance when he decided his trades with the roll of a dice. Each number represented either a long or short entry on one of three trading instruments. The first six times he used it to decide his trades, his trades were suÃ§cessful. Thereafter he decided not to push his luck. There's  a lot to be said for random trading on NFP nights!

Edit: I forget to mention - do not try that at home, my friend has an uncanny amount of luck with dice and card games!


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## minwa (16 December 2015)

Quant said:


> Does anyone else get so many questions in their first 2 days   ;-)




OK thanks for answering. 

As for the questions, do keep in mind that you are newly registered, and use big words and highlight profitability in almost every early post you made - that's my impression. Lots of ego clash. We also get many like these then they start advertising courses/wares. I mean no offense at all, just my observation.

Its more of a guilty until proven innocent culture here. And I think it's fair personally - it's the internet and the primary topic is money related.

I recall when RY/DS registered and also talked "big" was also "tested" with these questions/resistance initially is now a respected member.


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## Gringotts Bank (16 December 2015)

cynic said:


> ...an uncanny amount of luck with dice and card games!




LOA - you know it!


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## skyQuake (16 December 2015)

This question is more directed at craft and other f/a longer term players. 

How do you determine your expectancy? Its all well and good for 100+round trip/day ticker hounds to plug it into an excel sheet and spit out a number... But what if you've only did 4 trades this month and your havent closed out any winners ?


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## So_Cynical (16 December 2015)

The expectancy quoted in my signature is generated by my accounting software, i have no idea how it's calculated, guess that's keeping it pretty simple


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## cynic (16 December 2015)

So_Cynical said:


> The expectancy quoted in my signature is generated by my accounting software, i have no idea how it's calculated, guess that's keeping it pretty simple




Do you know whether unrealised pnl is included in that calculation?

Edit: scratch that question. The answer is already in the signature.


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## cynic (16 December 2015)

SQ and So C have just highlighted a further consideration with regard to expectancy. How is one's expectancy calculated in the event of increasing size of open exposure. Does one simply include a marked to market calculation for the open trades and then include that data in the expectancy calculations?


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## howardbandy (16 December 2015)

Greetings --

The thread starter seemed to be asking for a definition of mathematical expectation.  The conversation has wandered a bit since the first few replies.  I would like to make two comments.

One.
Expectation is the mean of the set of values being analyzed.  Define the set, and define the formula to be used, and the expectation follows.  In trading, a common definition of expectation is the arithmetic (or geometric) mean percentage return from a set of trades.  

Two.
The balance of a trading account after a period of trading depends on much more than the expectation of the set of trades.  There is some rocket science involved, along with some subjective analysis of the trader and his or her risk tolerance and personal utility function.  

The expectation must be positive over the period of trading for the account balance to be higher at the end than at the beginning.  There is no position sizing or money management scheme that will transform a system that has a negative expectation into a system that has a long-term winning profile.  It is, however, easy to lose money even with a system that has a positive expectation through poor money management.

Account growth depends strongly on the distribution of individual trade results.  Looking at the amount won when winning and the amount lost when losing is not adequate.  The distribution matters, and the sequence matters.  One of the premises of technical analysis is that the future resembles the past.  We cannot expect the exact same trades to recur in the exact same order.  But we do rely on the distribution of trades to be stationary.  If it is not, then the results of the system developed over the in-sample period will not be continued in the out-of-sample and live trading period.  So we must assume on a stationary distribution and work from there.  Here is a link to a presentation I made a few months ago about stationarity:
https://www.youtube.com/watch?v=iBhrZKErJ6A

Given a distribution of trade-by-trade results, or equivalently of daily-marked-to-market results, final account equity after some period of time or number of trades is also a distribution.  Pointedly, it is not a single number and it cannot be predicted with accuracy.  There is a central value of the distribution of terminal equity -- a mean or median.  And there is variation around that value.  For a given distribution of individual trades, we can estimate the risk of drawdown of trading that system.  Maximizing profit depends on the relationship between the risk of the system and the risk tolerance of the trader.  Here is a link to a presentation I made a few months ago describing treatment of risk in trading:
https://www.youtube.com/watch?v=Vw7mseQ_Tmc

Speaking specifically to wins and losses.  I have done considerable research into the characteristics of trading systems.  One analysis is as follows:
1.  Pick a set of trades to analyze.  These can be any set -- real trades, out-of-sample trades, in-sample trades, hypothetical trades.  Have enough trades to cover about four years.  It will become evident very soon that more trades provide finer resolution than fewer trades.  But a set of any size can be used.
A.  Sort that set into ascending order by trade result.  Largest losing trade at the left, largest winning trade at the right.  Just the percentage won or lost on the basic unit of trading.  No other position sizing.  Call this set "A".  It is the set that would normally be evaluated as the result of a backtest, for example.
B.  Copy set "A" and save it as set "B".  Remove the 5% of trades that are the biggest losers.  Resave set "B".
C.  Copy set "A" and save it as set "C".  Remove the 5% of trades that are the biggest winners.  Resave set "C".
D.  Copy set "A" and save it as set "D".  Add the 5% of trades from set "A" that are the biggest winners.  Resave set "D".
E.  Copy set "A" and save it as set "E".  Add the 5% of trades from set "A" that are the biggest losers.  Resave set "E".

You now have five sets of trades.  Set "A" is the original.  The others have either more or fewer winners or losers.  Evaluate the risk, maximum safe position size, and profit potential of all five sets.  One of the steps of the analysis is "risk normalization."  When risk normalized, risk of drawdown over the period of forecast trading is equal for all alternatives.  Given that, the set of trades that is preferred (by any rational trader / analyst) is the one that has the highest profit potential.

I have found, and you will find when you replicate my analysis, that the single most important thing you can do to maximize future profit is remove / avoid large losing trades.  It is more important to avoid large losses than anything else -- even at the expense of missing profitable trades.  The next important thing you can do is avoid a high percentage of losing trades.  Since we cannot expect the order of trades in the past to be repeated in the future, there is a chance that several losing trades will occur in sequence.  Without gains to allow the account equity to recover, these create a cumulative drawdown that will cause the trader's risk tolerance to be exceeded.

Each analyst needs to do this analysis him or herself for the system that will be traded.  Then adjust the rules of the system so that the distribution of trades gives maximum profit potential for your personal risk tolerance.

Thanks for listening,
Howard


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## So_Cynical (16 December 2015)

cynic said:


> SQ and So C have just highlighted a further consideration with regard to expectancy. How is one's expectancy calculated in the event of increasing size of open exposure.




You're making me think, over the years my open exposure is growing as my total portfolio value grows as a consequence of my position building and recycling capital policy, i have generally avoided locking in big profits to lower my tax bill.

Anyway - i think expectancy is a post trade completion measure, it's a figure derived from what has happened, open profit is something else - potential expectancy.


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## craft (16 December 2015)

skyQuake said:


> This question is more directed at craft and other f/a longer term players.
> 
> How do you determine your expectancy? Its all well and good for 100+round trip/day ticker hounds to plug it into an excel sheet and spit out a number... But what if you've only did 4 trades this month and your havent closed out any winners ?




Anything under the number of occurrences that starts to reduce the impact of randomness and dissecting your profit into the expectancy components isn’t really telling you much. One of the things that make long term investing hard is how dam slow the information feedback loop is.

So often I see this circular argument of what an edge is (hence the question to quant) – The answer typically being a statistically proven expectancy. (besides the bastardry of statistics normally involved) the next proposition then is typically  I have a statistically proven expectancy therefore I have an edge and around and around we go.  That sort of circular reference can’t happen with such a slow feedback loop, so you better damn well know what makes you the profit before going long term. 

Howards A-E experiment of position sizing is exactly what I was saying in the post below about win/loss ratio being important – It’s probably the missing piece of information I find the hardest to do without.  In long term investing we address risk of ruin by diversification across positions held and there is a lot of debate over how concentrated you should be to maximise profit and minimise risk. Time to get a statistical valid sample size under your belt is so slow you’re probably dead before you have a valid answer. 

I do things via a lot of individual parcels which ups the numbers of transactions a bit, so this year got the computer to spit out the numbers. Pretty meaningless really because the underlying decisions are still pretty small. For what it’s worth the numbers were posted here with a bit of following discussion. 


https://www.aussiestockforums.com/forums/showthread.php?t=25070&page=2&p=874305&viewfull=1#post874305


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## Quant (16 December 2015)

howardbandy said:


> Each analyst needs to do this analysis him or herself for the system that will be traded.  Then adjust the rules of the system so that the distribution of trades gives maximum profit potential for your personal risk tolerance.
> 
> Thanks for listening,
> Howard




Thanks Howard , you have expressed a lot of what I was trying to say . Everyone interested in system trading should have a look at Howards videos and read his book , absolutely full of brilliant information . I am sure it would even help every style traders .. repeating myself but this will help all traders regardless of style

" If you cant measure it , you probably can't manage it .... Things you can measure tend to improve "

Hopefully some will be more to willing listen to such a well regarded and peer reviewed expert such as Howard Bandy , We are very lucky to have him participating here at ASF


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## cynic (16 December 2015)

howardbandy said:


> Greetings --
> 
> ...I have found, and you will find when you replicate my analysis, that the single most important thing you can do to maximize future profit is remove / avoid large losing trades.  It is more important to avoid large losses than anything else -- even at the expense of missing profitable trades.  The next important thing you can do is avoid a high percentage of losing trades.  Since we cannot expect the order of trades in the past to be repeated in the future, there is a chance that several losing trades will occur in sequence.  Without gains to allow the account equity to recover, these create a cumulative drawdown that will cause the trader's risk tolerance to be exceeded.
> 
> ...



Thanks for taking the time to offer your input. I'm certain that I  am not alone in being impressed by your thoroughness.

I find your comments about profit maximization and the challenges regarding estimation of future performance from stationary data sets interesting in that they appear to highlight some key challenges to the translation of theory into practice. 

On the subject of sequential losses, would the incorporation of fixed fractional position sizing into one's system eliminate (at least in theory) the risks posed by distribution sequencing?


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## galumay (16 December 2015)

craft said:


> Anything under the number of occurrences that starts to reduce the impact of randomness and dissecting your profit into the expectancy components isn’t really telling you much. One of the things that make long term investing hard is how dam slow the information feedback loop is.




Yep, i think the main problem with discussions like this is people want a solution that fits all situations, and its just not going to happen. "Expectancy" and the discussion around it is specific to trading and very short term investing, and thats fine - those interested in this end of the spectrum should discuss its meaning and implementation in their strategies. 

Its not really relevant to long term investing and trying to shoe horn it into a strategy is unlikely to create much more than noise.

I have read about it and learnt a little about how traders use it as part of their strategy, but I dont try to fit it in my box of tools. Still its an interesting discussion and its good to see a new face at the table! 

I suspect that having made the rather obvious point about expectancy and its likely lack of relevance to long term investors, those of us of that ilk should probably let those to whom its important, continue the discussion while we observe from the sidelines!


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## cynic (16 December 2015)

galumay said:


> Yep, i think the main problem with discussions like this is people want a solution that fits all situations, and its just not going to happen. "Expectancy" and the discussion around it is specific to trading and very short term investing, and thats fine - those interested in this end of the spectrum should discuss its meaning and implementation in their strategies.
> 
> Its not really relevant to long term investing and trying to shoe horn it into a strategy is unlikely to create much more than noise.
> 
> ...




Whilst I agree that the statistical approach to calculation of expectancy may be unsuitable for those trading larger timeframes, I believe expectancy as a concept does still hold relevance to business in general.

This discussion would be incomplete without input from those trading time frames that demand an alternative approach to measuring the health of one's business operation.


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## howardbandy (17 December 2015)

Greetings --

Cynic asked about incorporating fixed fractional position sizing in the model to help reduce the effect of drawdowns.  My recommendation is to use the model solely to generate buy and sell signals.  Then monitor performance during trading and apply position sizing in response to recent trade results.  My view is that position sizing is a function of trading management, not of signal generation.

Continued good system performance relies on the continued good (stationary) relationship between the model and the data.  I think of that relationship as synchronization.  The system goes through periods where the model accurately identifies the patterns in the data you are looking for, resulting in good profits.  And periods when the synchronization is inaccurate, resulting in poor profits.  Overall, the system performance has a mean and a variance.  The system can continue to be operating within its expected performance, but trades show losses due to random sequences of misinterpreted signals.  

Eventually systems fail.  That is almost always due to changes in the data.  Those changes can be due to fundamental changes in the underlying market or company, or due to other traders also identifying the inefficiency your system is based on and reducing the profit potential for everyone.

We cannot tell when a drawdown is a normal excursion to the left side of the performance distribution or the start of a permanent breakdown.  That is, at the first few losing trades we cannot tell whether there has been a change in stationarity or not.  The best approach, in my opinion, is to treat every drawdown as a warning and reduce position size.  If / when the system recovers, increase position size in response to the recovery.  If not, take the system offline.  

Assuming a system will recover from a drawdown is a statement of faith that I do not share.  But many trading coaches do recommend "keeping the faith", "trading through the drawdown", "seeing an opportunity to double down and recover losses", etc.  The gain resulting from trading through a drawdown that recovers is somewhat more than the gain of trading at a reduced position size during the drawdown.  The loss resulting from trading through a drawdown that does not recover is serious loss of money.  Consider the reward to risk ratio.

In the early days of statistical analysis, mid to late 1900s, frequentist statistics prevailed.  Sir Ronald Fisher, of F-test fame, was the overwhelmingly strongest influence in statistical methods.  He was a bit of a bully and repressed views other than his own.  Beginning over a hundred years ago, and strongly gaining strength since Fisher's death, Bayesian statistical analysis has become more accepted.  Almost all of us who studied statistics further in the past than a few years ago learned frequentist methods.  There is a big difference between the two.  A Bayesian walks past a yard on Tuesday and a dog rushes out to bite his ankles.  On that same walk on Wednesday, the Bayesian is already alert for bad behavior.  The frequentist waits until there have been 30 experiences, then decides with 95% probability that the dog is dangerous.  In most of our decisions in life, we are Bayesians without thinking about the theory.  We should apply Bayesian techniques to trading as well. 

My point is that we can note trade-by-trade changes in trading behavior and make position size adjustments based on small samples of recent performance without waiting for 30 trades and near certainty.  The position sizing decision is based on performance and on a trading management model.  It is not a component of the signal generation model.

Thanks for listening,
Howard


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## 11bblandin (19 December 2015)

Greetings All

There's one point that has always bugged me about these types of discussions, which is the use of the arithmetic mean trade result as expectancy (typically expressed as Avg Win * Win Rate - Avg Loss * Loss Rate). This value is only accurate in two situations: fixed position sizing (always buy $10,000 of stock at a time) or if every single trade return is identical. Assuming we're taking advantage of compounding and using profits for future trades, using either fixed fractional or dynamic position sizing, the geometric mean trade result is more accurate. That is, if we were to take our (final equity/initial equity) ^ (1/ #trades), this would be the actual "average" trade result.

I only bring this up because I've seen it suggested that the expected equity after N trades is
(1+arithmetic mean)^ (#trades). This is incorrect and can be verified by looking at any backtest. 

For longer-term investors, you can use the daily/weekly/monthly returns of an account as a proxy for closed trades. Use these results to determine expectancy by more traditional methods. Also of note is the fact that systems that win frequently, even if average losses are larger than average wins, can utilize more aggressive position sizing safely because of the effects of compounding consecutive losses. Again, this can be proved out mathematically and Ralph Vince has done so in his books.

On a different topic, but one that Howard touched on, is how to determine whether a system is broken. I stole this approach from Kevin Davey's book, but I've found it to be effective. If you have a distribution of trades and use Monte Carlo analysis to predict future performance, you can generate confidence bands for your equity curve that create an envelope around where your equity curve could be at some point in time or after some number of trades if the system is behaving normally. If you plot your equity curve from live trading on top of these bands, you can determine with some degree of certainty (10%, 5%, etc.) whether the system is performing where you'd expect it to or if it is unusually bad.

Sorry for the rant


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## howardbandy (20 December 2015)

Greetings --

About arithmetic or geometric mean --
When a trading system issues signals and produces trades, or the equivalent marked-to-market daily returns, they are individual.  When analyzed as a distribution, each trade contributes a percentage gained or lost (or point gain or loss for futures or forex).  That distribution has moments -- mean, variance, kurtosis, skew.  That mean is defined by the equations of moments to be the arithmetic mean.  When a sequence of trades forms an equity curve, the analyst has some choices.  If every trade is taken with all available funds (traded at full fraction), the equity at any point along the curve is the product of the relative gain of the trades.  The final equity is the geometric mean raised to the power of the number of trades.  Given a set of trades that are traded at full fraction, the final equity (terminal wealth relative -- TWR -- using Ralph Vince's terminology) is independent of the sequence.  The drawdown, however, is Very sequence dependent.  Making a decision of whether to use a system to trade or continue to develop it based on a single equity curve is simplistic and includes a selection bias that leads to over estimate of profit and under estimate of risk.  That is the reason I recommend analysis of the distribution of trades to estimate the distribution of drawdowns at a given position size fraction, comparing the tail risk of the distribution of drawdowns to the individual trader's personal risk tolerance.  

Assumptions made in Ralph Vince's materials --
Mr. Vince assumes:
1.  Systems being analyzed are stationary.  So do most (read 98% or more) of articles, books, and presentations.  Systems are not stationary.  If they were, drawdowns would be opportunities to increase position size anticipating the return to the mean through an increase in the winningness of the system.  Whether a system is working or broken is one of the big questions of trading management.  Translated to statistics, that big question is whether two distributions -- previous performance and current performance -- are the same or different.
2.  The trader is comfortable with the high levels of drawdown that accompany high return.  The position size indicated by Kelly, optimal-f, and several other position sizing techniques produces exceptionally high returns, but experiences drawdowns well in excess of what most traders can tolerate.  As long as the trader has an indefinitely long time horizon, the system is stationary and guaranteed to recover, and the trader is able to take all trades at the recommended position size (similar to the table limits at a casino), drawdowns of 70% or higher are no problem.  Traders with limited funds, who trade systems that are not stationary, or who might need to withdraw funds from their account within the next few years cannot afford position sizes that high. 

About a system being broken --
I recommend a technique similar to that of Kevin Davey, but done on a trade-by-trade basis.  Using the entire set of trades is correct as long as the system is stationary (the terminology of an earlier post is "behaving normally").  The danger we have is that the regime underlying the system changes and the recent trades are no longer coming from the same distribution.  Frequentist statistical analysis waits for 30 (more or less) trades, then decides.  This style of analysis is OK when looking at backtesting results where everything appears in one run rather than trade-by-trade over real time.  Bayesian statistical analysis revises the working / broken response trade-by-trade.  Several of my presentations illustrate the technique.  My latest book has a detailed discussion, including computer code.

Thanks for listening,
Howard


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## Trendnomics (25 January 2016)

It is best to apply KISS to long term trend following trading systems - this has served me well. The greater the applied time-frame, the less accuracy is required (ideal for a retail trader).

I believe most people over-complicate things, by trying to control/validate parameters in trading systems to accommodate their poor trading psychology (i.e. unable to stomach losses). The greater the potential risk (i.e. draw-downs), the greater the potential reward (i.e. annual returns) - this fundamental concept is overlooked far too often when searching for the "holy-grail".


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