Friday, October 08, 2010

Some more thoughts on expectancy

Quite often you will see adverts of other traders promoting systems with incredibly high success rates, in excess of 90%. What they forget to tell you is that the wins are pretty small, and the losses (when they do come) will be monumental.

You quite often see this with trading robots, particularly in Forex. The wins can be as small as 20 pips, but the losing trades can be in excess of 300-400 pips. Even those winning trades can be in a big losing position before reversing. This is an example of cutting winning trades short, and letting losers run - the opposite of what trend followers do.

Those losing trades can have a devastating effect on your equity balance - traders (especially inexperienced ones) will tend to trade too big a position, and these kinds of losses can pretty much wipe out their account.

I would encourage anyone looking at such as system to carry out their due diligence, and quantify the expectancy of such a system, and NOT to be seduced by a winning percentage close to 100%.

Some of the best traders in history have accumulated their fortunes with a win rate less than 50% - a good trend following system can have a winning percentage below 40%. However, the losses are kept small, and the winners can be many times what is risked.

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