Odds of winning are constant: Using market bias AND stop loss

I have a theory that I'd like all you mathematical geniuses to tear apart for me please. It is simply this...Using a market bias AND stop loss you can improve your odds of winning from 40% to 66% using the following:

Theorems
1) There are only 5 possibilities inherent in any trade:
i. Long - win
ii. Long - lose
iii. Neutral - do nothing
iv. Short - win
v. Short - lose
This makes the chances for wining 2 out of 5 or 40%

2) By chosing to enter in any particular direction you eliminate 3 of the above 5 possibilities thus improving your odds to 50%.

3) There are only 4 possibilities when trading after entry:
i. Enter - win big
ii. Enter - win small
iii. Enter - lose small
iv. Enter - lose big

4) By using a stop loss you eliminate 1 of the above 4 possibilities thus improving your odds of winning SOMETHING to 2 chances in 3 or 66%.

5) These choices NEVER change and are always constant in the market.

Conclusion: Chosing the correct market bias, and using a reasonable stop loss produces a 66% chance of wining.

While clearly we want to choose the RIGHT market direction, and enter at the RIGHT time I found this little tid bit of clarity really has improved my outlook on the market.

Someone please introduce a bit of reality for me.

Position sizing is something that can affect the outcome either way. A trader needs to use the correct position size in relation to the risk/reward.

I cannot find flaw with your theorem. I would like someone with knowledge of market cycles to study this.

Q: Why are each of the possibilities in 1) equal to 20% each?
A: Because we have no evidence to the contrary, and equal distribution is the easiest assumption? (Like the way econometricians like to use Gaussian distributions)

But what if ...
1. ...you are using fundamental analysis and your reaction to news is late to a market that is anticipating future events?
2. ...there is a bid-ask spread, high transaction costs, or an intermediary that is taking profits from each transaction?
3. ...you use your guts to trade, and the market "is tricking" the masses to trade with fear and greed, psychologically hurting your chances?
4. ...there are institutionals/brokers gunning for your stops?
5. ...there are operators using pump and dump to sucker you in?
6. ...there is a network glitch that sends your order late during fast markets?
7. ...there are hidden bugs in your EA?
8. ...you have curve-fitted your trading system?

Any of these 8. cases or more would increase your probability of loss to be greater than 20%.

I am not trying to be negative or pessimistic, but in my experience, things glossed over or over-simplified tend to hurt more often than help. Maybe this is due to entropy or having so many speculators competing - I don't know.

But somehow, boo-boo's tend to fall on the sharp edge of the pnl knife.

Now how do you define "win" and "lose"? Do we agree on "closed at a better price than open" to be a winner?

If yes, then I do have an empirical proof of your theorem - I traded a whole lot this year, had about 1500 daytrade positions and it seems I have a roughly consistent 66 % win ratio on most traded pairs - a winner means I closed the trade at a price that was better (even if by only a couple pips) than open.

I agree position sizing is crucial - personally I use 100 pips = 1% capital

I have seen several theories on playable markets and position and maintain the following statement.

100% of all trades can be profitable in time.

The amount of profit is or may not be what you would like to see, but lets approach a couple of theories.

Murphy's 50/50 rule, which states:

Where ever there is a 50/50 chance, there is a 90% chance you will be wrong. I believe Murphy was deep into forex with a statement like that.

Let's rule out emotion and Murphy and leave it to a coin toss...the true 50/50...

Again, we are left with what are you expecting to profit and what are you willing to lose to get there? If this is anybodies idea of a chance in the market I have stated before and will state again, if you want to give away money on random chance, just send it to me, I am a good guy and will put it to great use.

Let's try another theory.

Given market movement, and a statement that was let out some time ago by a friend of mine, a workable theory at the time was to hedge a position on any one of the majors. Set a take profit of 100 in both directions. Given random market movement, and pivot points, there was when back tested a good chance of being 200 pips ahead of the game by end of the week if not month. This theory would most likely require a specific account set up with hedge capabilities and deep enough pockets to swing several pips against you before profit. I haven't checked the theory in over a year, but believe it to be still possible.

Now, given the way I see a lot of new people play the markets, this is not only a viable plan, but most likely a better plan then following random players that post in forums.

BEST PLANS

IF you want to never lose money in the markets, 100% guarantee, do not ever open a live trade account, otherwise there is always the risk of chance swinging against your favor.

Best strategy for winning...

When you find the Holy Grail, keep it to yourself, if we all played the same, the market would grind to a halt, and change the world of trading as we all know it.

Otherwise, come up with a system that you can depend on, back test it through the charts and forward test it "live", make sure you can kill the emotion in your trading, as most traders are their own worst demon when it comes to hitting the buy/sell.


I am a math guy, but sucked at stats...so rather than try impress you with numbers I wouldn't even understand by the end, I gave up and came up with this.

Keep Smiling!

I'm not even a math guy and my brain hurts but I'm glad you posted. I need to give my brain a rest because this is a good thread and deserves sound logic.

You hit on a very important point. Emotions, these can kill.

Emotions in check...

I have seen and still see a lot of traders <-(and I use this term loosely), have their asses handed to them, seeing statements read something to the effect:

Just as I exited, the market turned in my favor.
I got into this trade, what do I do now?
Buddy said sell, so I did, and now I am left with....

What killed me when I first started trading was dumb ass luck. I made a great trade, made a fist full of money, and it was all down hill from there. 7 accounts later....I can actually prosper at this game treating it as a hobby more than a full time career.

When I needed the money, I couldn't win a trade. My confidence so shaken, as soon as spread turned into -10 to -15, I was outa there. There became a time when I said, "Just hold, it will come back", I think this theory wiped out 2 of my accounts....

When the money is all gone, and all I was left to play with was 10 cent lots, I actually became a trader. Seeing that there really wasn't much left to lose, every trade became a victory, because if I was down 5 bucks, it was easy to make it back on a reversal.

I took a hundred and turned it into an account I can trade in dollar pips, scalp the market and let it scalp me back...

When I gets that loving feeling on the trades, emotion is gone, I am still only playing with $100 left from 7 accounts that has turned into something I can draw on as needed.

I have confidence in a trade system that plays with safety ranges, and have no issue with exit on a bad trade. This is my hobby, and I love the game!

Multi lots on very specific plays keep me green, non-directional scalps that leave me in the red are only a heartbeat away from trigger. I pick no bones. I play no favorites. In like a lamb, out like a lion.

Wait...not trying to hijack the thread, just saying....

If we can rule out emotion, we can then become traders.

(Of course I sound out a loud CHA CHING when I win, but hey, why the eff not?)

Missed one: "Enter - win or lose nothing", also called BE (Break Even).
Thread title makes sense: SL moves win from 40 to 50%.

In demo, I find 2-3 small losses is one big loss with a physical SL, unless you've an awfully high RR.
Also, "market bias" is a general impression rather than a specific reason, which calls for dropping the leverage used on these types of trades.

I get where you're from, tho; start with good odds, and much of the battle's won.

IMHO. Do nothing is NOTHING it's not a possibility. Otherwise

those who don't trade Forex also do nothing

1 Long - win
2 Long - lose
3 Short - win
4 Short - lose

And there is also Casino rule like 00 on the roulette= Spread.

Basically if you at the same time go short and long despite Hedging

rule, you still lose spread pips for Long and spread pips for Short

"Missed one: "Enter - win or lose nothing", also called BE (Break Even)."

Right, but to Break Even you still need to win those spread pips up to 7 sometimes and that's a lot

No matter how good your analysis, how good your signal and your market timing -the only difference between a winner and a loser is your psychology.

When fear is in control you are blind to the obvious.

I once, hours later asked myself why I didn't close and reverse instead of taking a loser.

Sorry to hijack the thread on emotions ruining good trading but the psychological aspect can be the deciding player. IMHO

You can't trade with scared money.

One of the problems is this: Even if your bias is correct, you may get stopped out too often. Since price moves like a honeybee (robbed from Bemac) rather than straight lines, your bias may be correct, but but a stopout is still possible. The tighter your stop, the more likely it will be hit even if bias is correct. The more generous your stop, the less likely it will be hit but... the increased amount risked with a looser stop will roughly offset the lesser likelihood of it being hit. The key to this theory (if there is one) will be finding the tipping point where the precise stop size/location give the most favorable amount risked/hit frequency ratio. Some will argue that it can't be found.

The point is, (and the OP has mentioned it) your real edge will be in having the correct bias. I don't think simply having a stop will give you an edge. If this was all that was needed, trading a large number of trades would have you in profit quickly.

I'm going to go another way with this.

First, the odds are not 1/4 just because there are 4 possibilities. That would assume that every possibility has equal odds. Instead, I'd argue that the possibilities of each change over time based not on your entry, but conditions that the market provides.

However I don't think your entry is the only thing that determines your outcome. Trade management (lot sizing, changes in lots, stops, etc) determine your exits, which is where your actual money is made. With the way most of us trade, all entries really determine is risk.


Indeed. As long as you're trading with leverage you need some place to hang your hat if the trade goes south.

Best point so far.

Beautiful Minds !

... a saturday afternoon well stimulated ... !

thank you people !

Surely you can create equal odds by defining SL/TP and MM (lot size)


As I point out earlier, "Casino" odds (spread) still there and it's has to be defined, cause it's very important. More frequently you trade,
more
money you need to make for the "House"

If you have

3 pips spread, just to exit without loss 1 Trade (Even) you'll still need to

make 3+3=6 pips

and many scalping traders scalping for 5 pips per trade.

Basically more you trade in specified period of time, more

you need to win for the "House" to stay EVEN.

Let's say you made 10 trades a day on low spread currency

3-pips. You'll need to win 60!!! pips for the "house" and then something for

yourself, if anything. And that's needs to be added to ODDS.

(spread * number of trades)/time period (also important)

That's why 98% of those 1M,5M traders will eventually lose money, guaranteed!

By trading less for longer term and going for the larger moves, ODDS of the "HOUSE" going

down and yours up.

I'm surprise nobody even mention that.

Wrong. By using a stoploss you eliminate iv but at the same time you increase the chances for iii. Every former iv will now be a iii and even a considerable number of trades that would have been winners will now hit the stop instead.

You can easily try this out by writing down the rules and let the machine test them for a few thousand trades on historic data.

Well, SL and TP, yes. Lot size has no impact on the odds of a trade. It may impact the odds of being profitable over multiple trades, but that's tangential to this specific point.

While you can create equal odds, you cannot create better than equal odds with SL and TP alone. Take for instance a randomly churning market, equal TP and SL would produce equal odds, but no advantage. Or in a highly trending market, you could shorten the TP dramatically and lower your expectancy if you want, but there's no point to that. Or I guess you could do the inverse and dramatically increase your TP by thousands of pips, returning your odds back to neutral.

I don't follow. If you have a 3 pip spread then all you need to overcome a 3 pip spread is 3 pips.

I don't see why you're saying 3-pips, but yes obviously you do have to overcome the spread on all of your trades. If you take 10 trades a day and the spread is 3 pips then you have to make at least 30 pips to not lose money. Assuming the same lot size on all trades. If your lot size is variable, things will be different.

Of course nobody says you have to be a scalper. My average aim per trade (varies on volatility, but still) is 30 to 50 pips.

I suppose so, yes. But from here we can use a little deductive logic. If what I said earlier is true, that an SL and TP cannot provide a positive increase in odds, but you must somehow overcome the deficit provided by the spread, then you get exactly what billflet said.

1. Your real edge is one that provides the correct bias
2. Simply having a stop won't make you profitable

Which takes us to what he said earlier.

Extrapolating from our logic, a stop loss is not to provide an edge but merely to minimize risk at the lowest possible cost to expectancy. A substantial feat.

I don't see how your logic for a specific trade yields anything for the general pool of trades here.

I would argue that while trading less means you pay less per spread in total, you still end up with the same spread per trade. Instead, trading for larger swings (as opposed to less or more) provides a better chance as your spread/profit ratio is much smaller. Trader for larger movements may or may not reduce your overall volume of trades.

(covering both statements at once, I know they were made by 2 different people)

In an absolutist way, yes. You eliminate the chances of a catastrophic loss, provided the system holds (liquidity insures your stop is activated).

But the relativist in me now re-defines these terms. Instead of talking about 1000 pip losses, a stop loss may reduce your loss to only 100. But that 100 is now "a big loss" in relative terms (perhaps literally, if you're scaling your leverage to match the new SL).

But yes, if the logic above holds then the many of your winners will now hit the hit instead, creating a trade-off for which we all must balance.

.

Even if you've entered and the market is going in opposite direction for some time, you still have possibilites to take profits, market is fluctating, so sooner or later price will reach level when you can take profits, but the thing is that it can be SOONER OR LATER, so we cannot predict if it will be 1hour, 1day, a month or even a year or a decade!

Its all about patience and long term perspective!

Well, its just my oppinion. Thx for suggestions!

.

First of all I want to thank all of you participating this seems like a good run. With that in mind I'm going to say a few words that will without doubt cause controversy so please follow the "logic" all the way through before publicly humiliating me.

Trading and Gambling while having some similar elements are NOT the same at all. Thus any reference to games of chance and trading using the odds commonly found in gambling are irrelevent and I'll explain why.

In Black Jack when you recieve two 10's or cards of the same value, while you can add to your risk, you cannot take 1/2 your bet off the table in profit and use the house's money to continue playing. Likewise if you bet on a football game or a fight, you cannot scale out of your bet when the score goes in your favor. That difference is huge. Trading allows you to "protect" your position at any time the trade goes in your favor, and this increases the odds that you will NOT lose.

In any game of chance there are certain "rules" of the game that you must abide by. These rules are what create the game and therefore the odds (which, by the way are ALWAYS on the side of the house). Thus the odds are finite and can be controlled...by the house mostly. If you begin to beat the house they not only refuse to play with you...they tell all the other casinos in the area who you are and send them your picture.

In trading there are only the "rules" YOU create the "game" itself is wide open, anyone with $500 can participate and often due. This makes the odds of any particular possibility INfinite. Thus more random than in a game of chance where the odds are fixed (against you). Thus it takes a great deal of effort to come up with a set of "rules" that can put you into a similar position as that of the "house" in games of chance.

Finally, in gambling, you must CHOSE to continue losing. Each game represents one chance and has a finite outcome...your bet. If you want to continue losing you must take action and place another bet. However in trading (for those who chose NOT to use a set stop loss) you do not have to do anything to continue losing. In fact you must take action to STOP losing by closing out your trade. That is why placing a stop loss on any trade improves your chances of winning.

While it may seem like and be just as addictive, with out the proper discipline, Trading is NOT Gambling...it is both better and/or worse depending on how you do it. And definitely far more difficult. Better in the sense that you can protect your position when the market goes in your favor, worse in that you can lose by doing nothing. Far more difficult to develop a set of winning rules and have the discipline to use them correctly.

That being said, refering to my original post, Neutral (do nothing) IS a valid position for one to take in the market. That first list are ALL the possibilities that exist PRIOR to entry.

As to break even...I admit this was a little short sighted as I NEVER use a break even stop...when I protect my position where most of us talk about a break even, I raise to break even + spread + commision/interest. Meaning I make SOMETHING for my effort. even a 2 pip win is better than break even or a 1 pip loss. Thus I NEVER have a zero trade...and always either win or lose.

This "theorem" I wrote does not and cannot take into account the many different ways to trade or methods of evaluating the market. But regardless each of the above possibilities always exist and must always be accounted for no matter how you trade. Going back to the coin toss. Even though the probability of "heads" are 50/50, that doesn't mean that 100 coin tosses will produce 50 heads and 50 tails...this is the difference between probability and odds. And that is why trading the markets is NOT gambling although it has many similar elements.

However I stand by the theorem as stated...trading styles and spreads, etc. do NOT negate or change the basic facts of trading. The only thing they change is how often that trade will land heads or tails, BUT IF you chose your direction wisely, place a reasonable stop, and time the entry well, the odds of having a winner are in your favor. Which brings me to my final point.

Casinos want you to lose...but the market "wants" you to win.

Perspective being what it is, and given the market movement, a large losing position today could be in the positive 2 days from now or. What makes it the win or the loss is definitely when you pull the trigger to exit the trade.

Speaking in absolutes, and I see a lot of traders still doing this, they speculate the top so they can enter the short, they speculate the bottom and will take the long. I am pretty sure that even if target was the actual nut of the play, a second play from opposite is less likely.

What I am saying, is that it is as impossible with market movement to actually nut the tops and bottoms whether you enter into a winning or losing situation as a you will most likely only be a day or days away from coming back to a zero trade.

Now, if you entered into a trade and then into a coma for 2 years...it's really hard to say if you would come out of the coma and the trade with profit, but speaking of active trading only.

Granted, I only watch and play Cable. I have traded other pairs as well as the metals, but prefer the relative rules of movement that it abides by. With cable, there is an expectation that it will strike the same price on the chart several times over the course of a day/week/month.

I don't think you can really include win big or small, lose big or small, it has to be down to win/lose and your own perspective of time and profit/loss, and what defines win or loss is when you exit the trade.

This brings it down to, what I stated in my first response, 100% of all trades over a long enough time can be profitable.