Chapter
Distribution of Trades
Idon’t know how many articles and seminars I have read and listened to that
stressed the importance of keeping your losses short. Many of them illustrated with
figures like Figures 17.1 and 17.2, which show the distribution of a set of trades
before (Figure 17.1) and after (Figure 17.2) a stop loss has been applied to the sys-
tem. In both figures, each column represents a number of trades ending at a certain
profit or loss. For example, the tallest column in both figures tells us that this sys-
tem had 17 trades that ended with a profit of three units (dollars, cents, apples,
whatever—it doesn’t matter at this point). Also, note in Figure 17.1 how the distri-
bution of the trades resembles the classic bell-shaped normal distribution.
As you can see, Figures 17.1 and 17.2 are essentially the same. The only dif-
ference is that a few trades have been taken away from the losing end in Figure
17.2. In Figure 17.1, the average profit per trade comes out to 2.8 units. In Figure
17.2, the average profit per trade is 3.31 units. Thus, the logic behind many of the
articles I’ve read and seminars I’ve listened to is that by cutting the losses short,
we can increase the profit per trade considerably (in this case by close to 20 per-
cent). Or can we? Before you read any further, look at Figure 17.2 for a while and
try to figure out what’s wrong with it.
Can you see it? What’s wrong is that the largest losing trades are missing
completely, as if they were never made in the first place, which they must have
been. To get it right, we need to add those large losers from Figure 17.1 to the col-
umn representing the number of largest losers in Figure 17.2. If we do that, the
result will be as shown in Figure 17.3. If you compare Figures 17.2 and 17.3, you
will notice that the leftmost column is taller in Figure 17.3 than it is in Figure 17.2.
With these trades prudently added back to the sample of trades, the average prof-
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