Money Management
is to have no exposure in the market! (This means that in order to be profitable,
we should not trade.) The best compromise is to design a stochastic R/r setup.
This means that in order to allow a position to experience the greatest profit, the
exit should be stochastic in nature. That would come closest to the never taking
a profit condition. In the stochastic version, the exit would inevitably occur, al-
though it is not known when the stoploss would be taken out.another uncontrollable factor: the Dreaded
Win‐loss Distribution
Let’s assume that a trader somehow has the ability control the %win and even
guarantee that it will never fall below the minimum 1/(1+R) condition. Does this
mean that the trader can now trade for a living and will then only be profitable?
Unfortunately, it is not as straightforward as just satisfying the minimum 1/(1+R)
condition. This is because the trader has still no control over the distribution or
sequence of wins and losses. For example, assume that a trader sets up a trading
system risking only 1 percent per trade, based on the original account equity.
This would afford the trader 100 trade units (i.e., 100%/1% = 100). Refer to
Figure 28.23.
We observe that if more losses appear first, the trader would have lost the
ability to recover even though his overall minimum %win remains at 50 percent.
This is because the trader has insufficient trade units to participate in the recovery
of the losses. This implies that in order to ensure long‐term survivability, a trader
should trade a system with the greatest number of trade units available, that is,
a system with the lowest %risk or $risk per trade. Again, it is interesting to note
that according to this train of logic, the greatest chance of survivability would be
to trade with a %risk or $risk of zero! Again, this would not be a viable option
in the real world.r/r ratio and its statistical edge in random systems
We learned earlier that a higher R/r is advantageous as it lowers the minimum
%win and thus makes it easier for a trader to achieve trading success. But does a
low R/r ratio have a statistical advantage or edge over a higher R/r with random
price behavior? Statistically, a higher R/r ratio setup will experience more small
losses with fewer larger wins, whereas a lower R/r ratio setup will experience morefigure 28.23 The Uncontrollable Win‐Loss Distribution.