Long Term Winning in a Negative Expectancy Game
***** Caveat***** Many will disagree with what I am about to write. If you cannot accept mathematical certainty, please do not waste your time reading this.
Trading retail forex is a negative expectancy activity. I hope all readers understand what negative expectancy is….but I will give a very brief description. Every trade taken opens with a negative in the profit/loss column because of the spread. This spread must be overcome on any trade before profit can be posted. If there were no spread, forex would be a game of neutral expectancy, meaning that overtime random entries could be made with equidistant profit and stop loss points. Over a large number of trades you would expect to break even. However, the spread makes that profit and stop loss points non-equidistant and puts forex trading in the realm of negative expectancy. If you go long E/U with a 2 pip spread, you must go a full 10 pips higher for a 10 pip gain, but you need only 8 pips lower for a full 10 pip loss. I hope that everyone can see that, from a probability standpoint, forex is negative expectancy.
So, how to overcome this negative expectancy? You must have a system that correctly predicts the direction of a currency pair at a rate of greater than 52% (give a 2 pip spread) while keeping profit and loss points equidistant. You may manipulate your system up or down this scale. For instance, you may decrease your win %, but you must proportionally adjust your profit point away from equidistant to compensate for the lower win rate.
Is there a system that can produce positive expectancy with equidistant profit/ loss points? I do not believe there is such a system available to small retail traders. I have seen many claims of such systems, but none that I have reviewed hold up to long term scrutiny. Please do not buy a retail forex system. If any of these systems could produce a positive expectancy, even a small one, the developer would be rich beyond their wildest dreams and not interested trying to get you to send them your money.
I have a winning system—how long until I am rich? Maybe you have access to inside information and can predict currency direction at a winning rate. You are still not home free. You must overcome randomness in the market and manage your money so as to not let randomness and volitility wipe you out. Consider the following: You have a system that produces 60% win rate given equidistant profit loss points. How many trades must I enter to be 99.9% certain of a win? N= log(1-.999)/ log(1-.60). This yields N=7.5. This number tells us that every 1000 trades you will hit at least 1 stretch of at least 7 or 8 losers in a row--- even with an incredibly high win rate of 60%. Don’t be surprised when these losses happen, they will happen to a mathematical certainly of 99.9%.
Some people make big money in forex. Absolutely some do. Some take accounts of $500 and turn that into $20,000 in a month. Some blackjack players take $500 and turn it into $20,000 in a few hours. Same for craps, roulette, etc. All these people are experiencing short term volatility in a positive way. It cannot be sustained and if they continue to trade or play for an extended period of time their account balance will be zero.
Conclusion. Please do not take this to mean I am a kill joy! I have traded forex for quite a few years and have had periods of great success, along with great disaster. I still trade from time to time, but I do it for fun, somewhat akin to casino gambling. If you are trading retail for any other reason that this, you will be disappointed. You may be successful for a few months or even years, but in the end if you trade long enough you will be wiped out.