Expectancy is always zero

# Thread: Expectancy is always zero

1. In fact, without some advantage, expectancy is negative because of commissions and spreads. Here's the reason why.

Most traders will be knowledgeable about the standard expectancy equation:

W = win rate
G = average Profit (or predefined TP when there's one)
L = average reduction (or predefined SL point if there's one)

Expectancy = WG - (1-W)L

This is similar to trading math 101 but it is extremely persuasive to new traders who believe that it is the trick to sure consistent achievement. After all if I cut my losses to ten pips, and let my transactions run to 30 pips, then if I win 30% of the time then I would still be ahead!

That is of course since (0.30 x 30) - (0.70 x 10) = 9 - 7 = 2 pips/trade.

Wow! Any dolt can be appropriate only 30% of the time, so all I must do is make a million transactions and I'll be up two million pips! Right? Right????

Ummm, no. :

Let's get beyond trading math 101 to another step. What's wrong with the train of thought over is that the win rate is actually a function of your risk/reward ratio.

For example if your SL is 20 pips from entrance along with your TP is 80 pips from entrance, then your win rate on transactions such as that should be around 20%. If you specify a stop at 20 pips and a TP at 5 pips then your win rate should be about
20 / (20 5) = 20/25 = 80 percent

So I am saying that in regard to the factors in the typical expectancy equation, the win rate is actually equal to: L / (L G)

So let us plug that into the expectancy equation and see what we get will we? We started with:

E WG - (1-W)L

but today we know that W = L (L G) so...

E = LG / (L G) - L L^2 / (L G) note: L^ is L shaped squared.

Multiplying the center term on the right by (L G)/(L G) that is 1:

E = LG / (L G) - L(L G) / (L G) L^2 / (L G)

mixing into one fraction with a common denominator:

E (LG - L(L G) L^2) / (L G)

E = (LG - L^2 - LG L^2) / (L G)

E= 0 / (L G)

E = 0

And that in a nutshell is why trading can be difficult. Just on tap bromides that are old like cut your losses and let your profits run, or you can't go broke taking profits, although they sound good will not get you everywhere.

Sure, if you cut your losses short, you know what you get? A lot of small losses that just about equal your big wins that are infrequent. If you abide by the opposite suggestions that you can't go broke taking profits, and opt to use stops and goals guess what? You get a lot of small profits that just about make up for that reduction you take every so often.

All of those cute slogans do nothing more than represent different points across the risk/reward spectrum, but traders should bear in mind that every one of these points has an expectancy of roughly zero. And that's not such prices. So forget the slogans. The trick to trading is to find an advantage that moves that E value to the positive side of your prices.

2. Originally Posted by ;
Hi,
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Wow, I am running off at the keyboard . But since you mentioned Atlas Shrugged, do you remember the scene where Fran buys his first copper mine using winnings in the stock market? His dad asks him how he learned to do that, and Fran tells him It is not difficult to determine which enterprises will succeed and which will fail. See? He had an advantage!!
lol d'anconia is just one crazy dude, so an edge might be partly defined as knowing something others dont...

3. Originally Posted by ;
nice read, something to consider...
lol d'anconia is just one crazy dude, therefore a border might be partially defined as knowing something others dont...
You phrased it exactly right in saying that we must understand something others do not. We do not always have to understand something that NOBODY else knows. We have to understand something that the trader on the opposite side of the commerce doesn't understand.

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