You would be forgiven for thinking that were you to be given a trading system with a positive expectancy, that it would be natural for anyone to be able to use this to make money trading. In actual fact, you’d be wrong – most people, even if they have a trading system with a positive expectancy will lose money. Ralph Vince (an expert on money management) did a study that can be used to illustrate why.
Vince took 40 PhD students, and had them play a simple gambling game, the rules are as follows:
* Each student was given $1000 play money
* They each had to place 100 bets (unless of course they lost all their money before the end)
* The game paid out 1:1
* Each bet had a 60% chance of winning
* The amount they bet was the only thing they controlled
So because the payout is 1:1 and the chance of winning is over 50%, this game has a positive expectancy.
In fact, if they bet $10 each time, they would expect to win $200 – ((.6*10)-(.4*10))*100
In reality, out of the 40 students, only two actually had a profit at the end.
This sounds crazy – we have such a simple system that anyone should be able to play to make money, yet only two out of the forty students ended up in profit!
The reason for this is actually quite simple – when someone is on a winning streak, people will often be afraid that it’s soon to end, and start betting less, and when someone is on a losing streak, the opposite will happen – thinking that a winner is just around the corner, they are likely to bet more. Invariably the winner doesn’t turn up, and before long a large portion of the account is gone. With over 50% of a bankroll gone, it is nigh on impossible to build that back up to break even.
This is known as the gambler’s fallacy, and is actually quite well known in the gambling world.
This of course translates directly to futures currency trading, or any other kind of trading, and shows how even with a profitable system, it is likely that someone who is unaware about correct money management, will still lose money.
So what can be done about this? Well the answer is simple – aside from learning about position sizing and money management, never open a larger position in a losing streak. Either keep your position sizes consistent, or smaller when you’re losing, and larger when winning.
jasmin agura
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