What makes successful trading so challenging is that it is possible to develop a positive expectancy trading model and still lose overall even if you
are properly capitalized and employ prudent rules of price risk management. The problem is best illustrated by the analogy of the opaque urn.1
An opaque urn containing 100 marbles is placed in the center of the room.
Fifty-seven of those marbles are green and 43 are red. Now I ask you to bet
on the color of the marble you will pull from the urn, and you pick green.
Out comes a red marble. I again ask you to pick the color of the marble,
again you choose green, and again you pull a red marble. Third time: You
choose green, and out comes a red marble. Fourth time, you again choose
green and again pull out a red marble. After the fourth loss, you begin to doubt. Maybe there are more red marbles than green. And so you either
stop betting altogether or worse still, you bet on the red marble.
. In particular, look at the
number next to the heading marked “MaxConsecLosses,” which stands for
maximum number of consecutive losses. As you can see, this positive expectancy model experienced four consecutive losses, despite producing an
overall profit of $64,420. This means that if you are either unable—because
of overleveraging on any particular trade—or unwilling—because of a lack
of confidence in the robustness of the model—to take the fifth trade after four consecutive losses, you do not enjoy the profit of $64,420. You
lose the maximum drawdown amount of $23,160 instead. Worse yet, if after four consecutive losses and a drawdown of $23,160, you decided not
only to abandon the model, but instead to fade2 it (that is, bet on the red
marble), your next trade would have resulted in a loss of $6,320 and total psychological demoralization. So it is not enough to have a positive expectancy model; it is not even enough to successfully manage the risk while
employing that model; we must also have confidence in its robustness during those inevitable periods when it underperforms.
Returning to the casino paradigm, how does the casino handle inevitable periods of player success? Do they become despondent, close the
casino, or start betting on the success of the players? Quite the contrary;
when players win, the casino goes wild with lights and noises, all emphasizing the point that despite probability favoring the house, it is possible
for players to win. The goal is to have the casino’s attitude of unwavering
discipline in the face of losses. As long as we truly have probability skewed
in our favor while adhering to rules of risk management, there is no reason
to abandon the positive expectancy model despite its endurance of losses.
We need instead to train ourselves to trade like the casino, adhering to the
probabilities and managing the risk 24 hours a day, seven days a week, 365
days a year. That is unwavering discipline, and that level of consistency
is the prerequisite for successful speculation. This being the case, there is
only one acceptable reason for abandoning a positive expectancy trading
model, namely, its replacement with an even more robust model.
❤️ Conclusion: TRADE LIKE CASINO.