What is an Edge in The Market & Why it Should Not link it to Win : Loss Ratio

By Jeff Kum | 18 January 2018

This posting is regarding my explanation of what is an edge in the market and why it should not link it to win : loss ratio. Where most traders thought high win rate more than 50% or by applying good risk-reward ratio, or by simplicity, as long as you make money, you have an edge.

You may have learned something from some guru or from some article which tells you what to do and give you the formula to follow, but you don’t understand why and how he designs the method. Then you might change the plan due to 1 or 2 losing trade and come with your formula and keep adjusting until you satisfy and make some money. But in the end, you still don’t know why you make money, and you thought you have an edge in the market because you make money.
Your next question is “I can apply good Risk:Reward ratio so I still can make money in the long run, so does it mean R:R also an edge?”. My answer is right R:R is not an edge. It just helps you to minimise the chance of losing money. You should not be applying R:R if you do not know what your advantage is.
For the better understanding of this situation, please look at 2 example below (sample only):

You observed that market would trend up most of the time after Christmas day. But you do not know how many times it will happen, and you don’t see how far it will go. So you will come out with an assumption report that we call it “hypothesis”. What you should do next is backtest and record it down. Once you have sure that your hypothesis is true and high probability to be correct then you shall have more information and some conclusion which part of it will be;

Sample 1: “Stock S will go up eight times out of 10 times after the Christmas day”. By your conclusion, you already can make money by applying 1:1 win : loss ratio on this stock.

Sample 2: “Stock A will likely go up triple from the opening market price before market close at evening (if stock A open at 1 dollar, it will go up to 3 dollars before day close). It happens 3 times out of 10 times after the backtest”. From this info, you may have 3 wins, and 7 loses, but you can apply 1 risk and 3 rewards for this time and still make money.
So you may not be able to apply right R:R on case 1 due to lack of some details, but you can use it on the second sample.

My conclusion is, so both info also considers as an edge regardless of win:loss ratio.

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