The formula doesn’t consider either the amount of reward or risk. It has only % winning. A trader does not lose the same amount that he gains in a winning trade in every losing trade. If differs based on the risk reward ratio. If both are the same your formula seems to make sense. But in reality a trader may risk 1% of capital and aim at 2% gain. If that is so he will be profitable with a winning percentage of less than 50. So my point is edge doesn’t define if you are a winner are not. How much you risk with you edge and how much you expect to gain with your edge determines whether you are a net winner or loser.
Sorry to be saying this but you have got it all wrong. Please pay attention.
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You say:
The formula doesn’t consider either the amount of reward or risk. It has only % winning.
My response:
There is never an “amount” of reward OR risk. It’s always a ratio of risk TO reward. It’s called the ODDS. It is covered in the formula (the “o” in AoW stands for “odds”).
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You say:
A trader does not lose the same amount that he gains in a winning trade in every losing trade. If differs based on the risk reward ratio. If both are the same your formula seems to make sense
My response:
If both risk and reward are same, then it’s called an even-money chance (odds of 1 to 1); I am certainly NOT talking of that since I am asking to compute “average” of odds on ALL winners. It clearly shows I am assuming variable odds.
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You say:
But in reality a trader may risk 1% of capital and aim at 2% gain. If that is so he will be profitable with a winning percentage of less than 50.
My response:
That’s called the odds of 2 to 1. For the average odds of 2 to 1, the trader can make money as long as his win percent does not dip below 33.33% or 0.3333. Let me put these figures into the formula to make this point clear.
Edge = 0.3333 * 2 - (1-0.3333)
= 0.6666-0.6667 = 0 which means neither positive nor negative edge, that’s the break even point for the trader.
But the moment his win% dips below 33.33, say it touches 25% or 0.25, then the odds of 2 to 1 will make him a long term loser. He will lose 25 cents on every risked dollar in the long run.
Edge = 0.25 * 2 - (1-0.25)
= 0.50 - 0.75 = -0.25
For this trader with a 25% strike rate, he must score at average odds of 3 to 1 to break even. Check this:
Edge = 0.25 * 3 - (1-0.25)
= 0.75 - 0.75 = 0
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You say:
So my point is edge doesn’t define if you are a winner are not. How much you risk with you edge and how much you expect to gain with your edge determines whether you are a net winner or loser.
My response:
Hope you have now understood the fallacy of your statement which I have highlighted in bold typeface above.
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A note:
I come from the field of horse racing, and I am surprised to find that such an elementary concept as EDGE gets debated here and needs to be explained.
To sum it up:
This Edge formula states a fundamental fact about any speculative activity.
And there is no way around it.
If your E value is negative, you will be a long term loser. There is no point in risking serious money unless you can improve your winning percentage OR your average odds on winners (reward to risk ratio) OR both.
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Understood. I misunderstood your previous reply. Thank you.
I should also share the blame. I think earlier I was not as clear as I should have been.
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My response was hurried and crude. I apologize. You’re a much more knowledgeable and experienced person than me. I misjudged.
And thanks for the detailed explanations.
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We all have our irrational moments. Let’s look ahead.
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