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EXPECTANCY
Las Vegas. Great food, show-girls, and a multi-billion dollar gambling business. The money made by the casinos is only matched by the profits on Wall Street. And the profits of both are based on mathematical probabilities.
Casinos make money because “the odds” or a game’s expectancy are in the house‘s favor. This means that if you play long enough, the casino wins. Over the short term, the casino knows it may win or lose. But if you play long enough, the house always wins. The casinos increase their profits by offering games that are completed in a short period of time - a roll of dice, a spin of a wheel or a few cards turned over.
What does this have to do with trading systems? We want the odds of a trade to favor us - expectancy We want a lot of trades - opportunity We want turn over so we can compound the profits - holding time.
What we as traders must do is become the “house”. The odds in our trading must favor us, we need a reasonable number of trades during the year and the trades must be completed in a reasonable amount of time for compounding to be effective.
Expectancy is simply the product of your average profit per trade, which is your profitable trades minus your losing trades divided by the total number of trades.
If the margin on trading a large s&p 500 contract is, say $19,000, then your average profit of say $468 divided by your margin results is a profit – each trade, of 2.46%. That may not sound like much but is better than the casino gets on its blackjack table.
The bottom line is: expectancy must be positive if you want to make a profit over time. Never use a system with a zero or negative expectancy. You will not win. You cannot beat the house over a long series of bets or trades. Be the “House”. In other words, your average results per trade must be positive, not negative.
No matter what your expectancy is, you will not make a great deal of money unless you have a lot of opportunities to trade. Again, the casino analogy. The casino may only make 1-2% per hand of blackjack, but they turn over those hands very quickly - 50 to 60 hands per hour. Play blackjack long enough and you will lose your shirt. No wonder they can offer those wonderful comps.
The most overlooked area of trading is the "holding period." In order to make money, you must have a system that generates a positive expectancy and a lot of opportunities. But you must have access to your money. If your trade’s hold time is too long, you can't take advantage of all or even most of your opportunities. Your trading money or buying power is always tied up because you have to wait too long to close your trades.
Casino analogy time. If the house odds in Blackjack are 2%, that means for every $2 bet, the casino makes, on average, 4 cents. If you only play 1 game per hour, the casino makes 4 cents per hour. If you play 50 games per hour, the casino has all of your $2 in one hour. All things being equal, the game with the fastest turnover is the more profitable for the casino.
It’s no different with trading. If you have an average profit per trade of $468, but have only one trade per month, you would be ahead of the game by $5616 in one year. But if you had 300 trades in one year, your year-end profit would be over $140,000. Which is more like it.
The bottom line for a great bottom line is: A positive expectancy A good number of trades A short holding period
GOOD LUCK AND GOOD TRADINGBACK |
