IP Lesson 6 Flashcards
BIG IDEA : Describe the concept of trading an edge.
Trading an edge means having a positive profit expectation based upon a mathematical probability model, and then aligning my real world behaviour and trading activity as closely as possible to the strategy derived from the model.
Why is trading an edge vital to your success as a trader?
Because it is the mathematical edge which ensures profit over time.
Why is it important to understand the concept of trading an edge itself?
Because it allows me to realistically align my expectations towards profitable trading.
How is basic probability calculated?
The number of ways an event can occur, divided by the number of possible outcomes.
In the example of a coin flip, the probability of flipping a head is 1 ( it can only occur one way ) and the possible outcomes are 2 ( heads or tails ) . In this case, what is the probability of flipping a head?
1/2 = 0.5, 50%
In a simple 50/50 event, what is the profit expectation if the same profit or loss is applied to both probabilities?
( $1 x 0.5 ) + ( -$1 x 0.5 ) = ?
0
What is the profit expectation when a 50/50 event has a $1 upside, but only a $0.9 downside?
( $1 x 0.5 ) + ( -$0.9 x 0.5 ) = $0.05
What are the 4 factors affecting profit expectation?
Win rate, loss rate, Profit on wins, cost on losses.
Why is it that sticking to a strategy, even one that is sure to make money, can be a challenge for traders?
Because the brain needs training to think in terms of probability.
In general, do people favour or aver risk when considering gains?
Risk averse.
In general, do people favour or aver risk when it comes to losses?
They favour risk.
How should one deal with losing streaks which occur after one has a confirmed profit expectation, and strict adherence to the rules?
Understand that only over the long term can the system generate consistent profit.
What is the only way to ensure the value of your edge?
To play it consistently over time.
What does the law of large numbers state? ( in regard to trading )
The higher the number of repetitions, the closer to profit expectancy.
What characterizes the beginning samples of a probability model?
They are totally sporadic.
When should a probability model be expected to settle into it’s expected outcome?
Over hundreds of repetitions.
With regard to the rules casinos follow for their own business model : How do they handle not knowing if they will make money on a given spin?
They don’t need to know.
With regard to the rules casinos follow for their own business model : Why do they not need to know if they will make money on a given spin?
They make money from positive profit expectancy.
With regard to the rules casinos follow for their own business model : How do they maintain positive profit expectation?
Have strict rules and never break them.
With regard to the rules casinos follow for their own business model : How do they handle losing streaks?
Staying calm and sticking to the rules!
With regard to the rules casinos follow for their own business model : How do they move towards their “expected outcome” & positive profit expectation?
Ensuring they can participate in as many games as possible.
In regard to calculating profit expectations for trading, what does a 1:1 strategy refer to?
Risking 1% to make 1%
How to enter a 1:1 trade?
Set stop loss and profit target equal distances apart.
Once a 1:1 order is live, what are the two options the market can choose?
Move and trigger either the stop or the target.