I wanted to bring up a very basic concept that seemed to throw off a more senior member in a distant thread; which is the concept of edge and expectation. A certain book had published tables on win and loss rates for a study the author had done. The poster mentioned that the edges were 'very weak' therefore, why on earth would they publish such a book. To my astonishment, several other posters chimed in with agreement.
I don't want to show the exact table because I'm trying to avoid sounding like an antagonist. But the basic concept was that the author had run millions of trials regarding the outcome of betting that a certain pattern would generate an edge. His initial hypothesis on a certain pattern was that it would generate positive moves following its appearance. He shared several basic observations in tabular format. Following are some of the metrics...
1) Win Rate
2) Loss Rate
3) Avg Gain
4) Avg Loss
The above were also tabulated for gain following several days of the pattern occurrence. So, we have everything we need to calculate basic mathematical expectation or edge.
Now here is an example of the IMO, egregious conclusion drawn by our more senior poster. Over 14+ million observations, the author tabulated
a 42% win rate with an average gain of 3.37% and an average loss rate of 58% and an average loss of 3.44%. The initial perception of a neophyte might be to calculate the expectation as E[x]=Aw%*Aw+Al%*Al or, .42*.0337-.58*.0344=-.0058 per trade or -.58% per trade and conclude it is a losing edge or system.
My initial reply was that a 58% win rate was respectable, to which the senior member was quick to reprimand me for misreading the table, which clearly showed it was a 58% loss rate. Now here's where I draw the contention and it would be a shame for others to draw the same misleading conclusion: It is only a 58% loss rate, if you are viewing it from the perspective of long only. You can easily take the same one day pattern and reverse direction to get both a positive hit rate and a positive expectancy.
i.e. the above equation becomes (+).58*.0344 (-).42*.0337=(+).0058/trade.
What we are looking for is expectation in any system being something other than zero (and ultimately positive). In terms of hit rate, we want something at the very least to be better than 50/50 (the market bias alone has this characteristic with positive drift, therefore relative to the market you need to compare biases, but that's another story).
Now assuming you agree with my contention on edge semantics, is .58%/trade weak? That depends on trading frequency and friction.
I would argue given a relatively high amount of capital to friction per each trade and a decent trade frequency, it is not weak at all. Is it statistically significant? For 14million trials, I would say so. While I'm not a big fan of many basic TA books, I applaud the author for his work here and do not at all consider it a waste of publishing time. I will take this type of book any day over the deluge of books available with zero stats and pure subjective commentary.
2c
I don't want to show the exact table because I'm trying to avoid sounding like an antagonist. But the basic concept was that the author had run millions of trials regarding the outcome of betting that a certain pattern would generate an edge. His initial hypothesis on a certain pattern was that it would generate positive moves following its appearance. He shared several basic observations in tabular format. Following are some of the metrics...
1) Win Rate
2) Loss Rate
3) Avg Gain
4) Avg Loss
The above were also tabulated for gain following several days of the pattern occurrence. So, we have everything we need to calculate basic mathematical expectation or edge.
Now here is an example of the IMO, egregious conclusion drawn by our more senior poster. Over 14+ million observations, the author tabulated
a 42% win rate with an average gain of 3.37% and an average loss rate of 58% and an average loss of 3.44%. The initial perception of a neophyte might be to calculate the expectation as E[x]=Aw%*Aw+Al%*Al or, .42*.0337-.58*.0344=-.0058 per trade or -.58% per trade and conclude it is a losing edge or system.
My initial reply was that a 58% win rate was respectable, to which the senior member was quick to reprimand me for misreading the table, which clearly showed it was a 58% loss rate. Now here's where I draw the contention and it would be a shame for others to draw the same misleading conclusion: It is only a 58% loss rate, if you are viewing it from the perspective of long only. You can easily take the same one day pattern and reverse direction to get both a positive hit rate and a positive expectancy.
i.e. the above equation becomes (+).58*.0344 (-).42*.0337=(+).0058/trade.
What we are looking for is expectation in any system being something other than zero (and ultimately positive). In terms of hit rate, we want something at the very least to be better than 50/50 (the market bias alone has this characteristic with positive drift, therefore relative to the market you need to compare biases, but that's another story).
Now assuming you agree with my contention on edge semantics, is .58%/trade weak? That depends on trading frequency and friction.
I would argue given a relatively high amount of capital to friction per each trade and a decent trade frequency, it is not weak at all. Is it statistically significant? For 14million trials, I would say so. While I'm not a big fan of many basic TA books, I applaud the author for his work here and do not at all consider it a waste of publishing time. I will take this type of book any day over the deluge of books available with zero stats and pure subjective commentary.
2c