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Thomas Pfluegl <thomas.pfluegl@xxxxxxxxxxxxxxxxx> wrote:
> I did a small test with Excel (coin toss, which is a 50/50
> system), to reveal how many Consecutive Losses are 'necessary' to
> suffer a 50% drawdown
Is that a 1:1 payoff system, i.e. Heads wins 1, Tails loses 1?
If so, its expectation is zero. It's a breakeven system before
considering commissions or slippage. No sane trader would trade
something like that.
If your expectation is positive, you have more breathing room. E.g.
if your system hits 50% wins, but the avg win / avg loss ratio is
comfortably larger than 1, you would expect the account to grow much
more rapidly. Wins would dig you out of the hole faster than the
losses were digging you into the hole.
Of course, that doesn't help the worst-case situation of N continuous
losses. But a good trader would reduce his size as the drawdown
deepens, thus extending his survival time to hopefully outlast the
string of losses.
> A simulated coin toss expectation game (which ran almost a week)
> showed, that one must expect up to 20 (probability: 1 : 1.048.576
> or 0.000095%) consecutive profits/losses in a 50/50 system!
Personally I'm quite comfortable risking against 1-in-a-million odds.
Hell, my odds are worse than that every time I drive my car.
I actually take much higher risks than that. When I started out, my
system was hitting just about 50% wins. At the rate I originally
traded the system, I was risking 10% per trade. (And that's assuming
no exceptional adverse events, e.g. bad gaps against you. That was
probably pushing it harder than I should have.) At that rate, 7
losses in a row would have been enough to knock me down 50%. With a
50% win rate, that's a 0.7% chance. I'm very comfortable with a 1-in-
128 risk. Especially since I can always reduce my risk by reducing
size as the drawdown deepens.
As my account grows, I'm reducing my risk per trade. I've quit
holding overnight (which drastically reduces the chances of an
adverse event) and I've reduced my risk to about 5%, with the
intentions of reducing it a bit more in the near future. By taking
that level of risk, I was able to get high enough returns that I'm
very satisfied with my risk/reward tradeoff.
In my opinion, anyone who doesn't want to risk a 1:1000000 chance of
ruin shouldn't be trading. They should put their funds into a money
market account. Or perhaps into their mattress, since there's
probably a 1-in-a-million chance that their MM fund could go under.
Or the currency could be devalued. Or ...
Gary
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