Difference between definitions of positive expectancy

fatowl

Junior member
33 0
Hey all! Just wanna say first that T2W rocks. This is my first real post. I've been lurking for quite a while and decided that I could learn and contribute so much more than just reading all the forums. "Trading Systems" is my favorite subforum on T2W. Good stuff!

On to the main topic...

Some people get confused by the definition of positive expectancy. There are two definitions: percentage terms and absolute terms.

It is easiest to think in percentage terms when debating whether a trading strategy works. For example, let's say you made your very own unique buy/sell rules for the E-mini S&P 500. And over the past 10 years, your backtest produced 100 trades and has shown that your trade expectancy is +0.5%. This is excellent, however you have not taken into account money management or risk management.

Let's say in this same system, you're always betting 100% of your account value on every trade. This is idiotic, of course, but just stick with me here... Let's say that each of trades #1 to 10 were really big losers. Let's say your account dropped by 75% over those 10 trades. Then, trades #11 to 100 were typical winners and losers. By the end of the backtest, your account value is lower than where you started. This means your trade expectancy in absolute terms is negative!! That sucks!

This system is salvageable!

With better risk management and money management, your expectancy in absolute terms can become positive. Just go back to your system, and bet 10% of your account value on every trade (for example). Or always bet a fixed amount like $1000. Your trade expectancy in absolute terms will change and hopefully will become positive.

Moral of the story: whenever someone says that it is impossible to have a profitable trading system with negative expectancy, they are talking in absolute terms.

It is theoretically POSSIBLE to be profitable and have negative expectancy in percentage terms. It will be very hard, but risk management and money management are your keys to creating positive expectancy in absolute terms.
 
 
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