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Is this a valid approach from a statistical standpoint?
I have a question concerning a trading rule, which I have come across from 2 different Gurus. The one explained it directly the other had it somehow hidden in his rules.
Here it is in my words:
Letīs assume we have a trading strategy that is basically 80% winning, but the outcome is more or less breakeven.
So the 20% loosers eat up all the winners.
Now the rule is to stop trading when 3 winners came in a row. Because - they say - after 3 winners in a row the probability of encountering a looser gets too high. Now you either stop trading for the day, or at least till the next looser passed by untaken.
Is this a valid approach to skip the low probability loosers, and transform a breakeven strategy to a winning strategy?
As far as I understand statistics it is not possible to know, where the winners ( or loosers) come in.
But is it possible to have a probabilty of a series of winners in a row? Like 3 or 4 winners in a row, with a basic 80% winning strategy for example??
Can you help answer these questions from other members on NexusFi?
You have to keep stats on everything and see how things are affected. But from my experience using a method like that does not work. Probabilities are extremely important but there is just no way to determine whether next trade will be a winner or loser based on previous 3 trades. On a surface level when I look at my stats I think something like that would work but when I put it through extensive testing it does not. It just does not stand the test of time over many trades.
"The day I became a winning trader was the day it became boring. Daily losses no longer bother me and daily wins no longer excited me. Took years of pain and busting a few accounts before finally got my mind right. I survived the darkness within and now just chillax and let my black box do the work."
It's not impossible if there is some sort of relationship between the result of sequential trades. Usually this works the other way around though, i.e. several losing trades may indicate a change in market regime into an unfavorable environment for a particular strategy. Not sure what the rationale would be for not trading after several winners.
In any case, you'd have to establish such a relationship robustly by analyzing a long sample of trade results.
But only if the single trades are completely uncorrelated. In which case the approach of skipping a trade would not work as the chance that the next trade will be a winner would always be 80% regardless of the outcome of previous trades.
However, if the trades were correlated in some way or another, which they probably arent (to any significant degree) the approach could work (or perhaps the opposite approach).
The only way to find out is to keep extensive trade records, kind of like train spotting, only more compulsive
Another thread talks about this which is the "Gambler's Fallacy". I'm providing the link to the first post in the thread but it very quickly gets into what you are talking about.
There are just too many unknown variables that can affect the outcome...
If a system is a trend following system , the trading day is a strong trending day ... and the market is in sync with your system ... you can have all winning trades ... unfortunately, you will hate yourself because you stopped trading after the first three winning trades
The same system on a very choppy or range bound day could produce all losers ... unfortunately you will hate yourself for continuing to take trades waiting for the 80% wins to kick in
Some days the market showers you with gold ...
Some days it just gives you "Golden Showers" ....
I'm just a simple man trading a simple plan.
My daddy always said, "Every day above ground is a good day!"
It is connected to the gamblers fallacy. Talking about uncorrelated trades the chance is always 80% (in this example) for each INDIVIDUAL trade seen as a single, uncorrelated event (which it is). The chance for four winners in a row would be 4 = 0.8 ^4 = 40.96%. BUT the fourth trade of this series (regardless of the outcome of the previous 3) always has a 80% chance.
So if you skip trades in a system where the trades are uncorrelated or insignificantly correlated, you gain nothing, other than experiencing the gamblers fallacy first hand