Basic Market Math for dummies

Basic Market Math for dummies

To any trader out there that wants to be successful in trading, you must know the following:

1- The number one tool a trader must be equipped with is a trading system, It is important that your trading system would make more profitable trades than loosing trades, i.e. your win percentage should be at least >51%. Remember las vegas casino owners built their wealth using a very slim margin close to 1% edge vs. the customers (i.e. 51% wins vs. 49% loss to customers) This also means that when you pick a system backetest it well its preferable if you backtest it over 10 years worth of data which will validate your results vs backtesting it two weeks and using that as a result.


So you have your system all set up and it has an edge greater than 1% now lets move on to the more important part:

2- The risk to reward ratio, in pips of course, should be 1:1 or better, it must be that the reward number is always greater than the risk number, so that you win more or equal to what you loose not loose more than what you would win, or else you will be a looser in the long run no matter how good of a system you have (and remember there is no such thing as a 100% accurate system)

3- Third, your understanding of the 2% risk rule, many traders out there will tell you “make sure your position is no larger than 2% of your account so you don’t loose more than 2% on any one trade blah blah blah” that’s retarded, it doesn’t matter how big your position is AS LONG AS YOUR STOP LOSS IS EQUAL TO 2% OR LESS OF YOUR ACCOUNT (what ever percentage of loss you are comfortable with), so that in this case you never loose more than 2% on any one trade.

Now you can truly have a mechanical system, where there is no thought process required to make money, lets say you have a system that wins 70% of the time at a ratio of 1:1, so you either gain 2% of your account or loose 2% on any one trade, if you started out with $1000 after 100 trades you would have doubled the account because of compounding (i did the test using a program in the excel file i attached description is below.)




Finally for those that say they can win with less than 50% winning ratio ect. this is only one way I believe one can trade the markets, there are many other ways to make money but I think IMHO this is probably the simplest and thoughtless way to trade you basically use a system mechanically using this type of money management, all u do is take the trade knowing you will either win or loose but you really don’t care weather you win or loose this round because overall you will come out a head. But before you go and act exactly as I described you need to do the math for your self, look at what is the maximum drawdown you can take, look at how frequent your system trades and make sure you don’t use more than 10% of your account at any one time (over several trades that is). also budget your stops so that you don’t loose more than 10% at any one time (over several trades) because you might get hit with 5 losses in a row. you will need to work out some equations at the beginning but after that you will just have to follow your plan blindly knowing that you will come out ahead eliminate any emotions and you’ll be good and save your self lots of time and headache lol!

Attached is an excel file that has a visual basic program that will tell you using a system with a certain win percentage and a 1:1 win ratio what would be the out come after however many number of trades you wish to test.

Feed back is appreciated!
Hopefully this helps out some people out there



G-dogg

I agree with most of what you said. I am not really a fan of back testing. I'm not saying it has no use, but it certainly has it's limitations. Most strategies based on back testing are curve fitted at least to some degree and often do not perform the live when tested live.

as for backtesting, its always better to do it manually, for example im working on a weekly system and am definatley gonna backtest manually over 10 years.

Hello G-Dogg,
Not sure if I understood the way number 3 was worded. Maybe this will clarify.

It's important to know the sequence of arriving at the 2% risk.

1. When you see a trade opportunity, determine how many pips away your stop loss needs to be by locating a fib level, or support or resistance, or whatever your strategy tells you.

2. After you decide where your stoploss will be, count the number of pips between entry and stoploss. For our example, say that you decide your stoploss should be 30 pips away.

3. Determine how much money you can risk. For example, you have a $9000 mini-account and are willing to risk 2%. Your risk should be no greater than $180.

4. Divide $180 (amount to risk) by 30 pips (your pre-determined stoploss). You can risk $6 per pip or 6 mini-lots.


Never decide your lot size before defining your stoploss. Your stoploss should be determined by your strategy.

Thats exactly what im saying, my bad if its not too clear.

I thought we were on the same track.

Re: Backtesting.
Find a Free Platform that allows you to "Load Data" up to a specified date. {preferably BACK (at least) 50% from Today's bar on your Chart}.
Run your tests on the Initial Data and Then load the remaining ~ 50% of Data and re-apply your Strategy.

If it is worth persuing, the Signals on the Last 50% of the Chart will be "At Least" as good as the First 50%.

hth.

re the first post market math for dummies.........., one of the best posts i've seen on ff, props to g-dogg.

Very happy to see that my post helped out at least one person lol!

nice one! pickced up a few things.