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-- 9.080 "The reason why 'big losses, small gains' is a method that always ends up losing"
Today is an unusual column.
There is a famous prospect theory in behavioral economics.
"People feel more pain from losses than pleasure from gains"
Profit seeks to be obtained reliably, while loss seeks to be avoided like gambling.
Profit seeks to be obtained reliably, while loss seeks to be avoided like gambling.
This is the tendency.
If you follow this, you will become very likely to lose.
Once you cross a certain line, you will inevitably lose.
Once you cross a certain line, you will inevitably lose.
Why is that? I would like to dig deeper.
Prospect theory is a concept that many people are familiar with as knowledge, but
From the perspective of compound interest and fund management, a deeper understanding can be gained.
From the perspective of compound interest and fund management, a deeper understanding can be gained.
According to prospect theory, losing trades are as follows.
Taking profit with a small unrealized gain, while enduring unrealized losses until the cost price.
However, by the time reluctantly cutting losses, it may result in losses exceeding 10% of the assets ratio.
If there is an edge, even with a big loss, you can expect a positive overall result, but the winning percentage is high.
The high winning percentage is due to the wide range of stop-loss orders.
If there is an edge here, will it lead to a positive total?
Unfortunately, it will not happen.
Unfortunately, it will not happen.
In order to return to the original assets with a loss of more than 10% of your assets,
You need a recovery of 11% from the reduced assets.
You need a recovery of 11% from the reduced assets.
The reason it's not 10% is because it assumes compound interest.
If the asset ratio is 20% loss, a 25% recovery,
a 50% loss would only return to the original capital by doubling the assets.
a 50% loss would only return to the original capital by doubling the assets.
The recovery of this asset must be done only by taking minimal profits.
Is it really possible?
Since there are no big wins, it comes with difficulties.
The process of steady gains may happen repeatedly.
The process of steady gains may happen repeatedly.
Many investors and traders are
While it is said to "accumulate profits steadily",
this expression is not good with a trading method based on Prospect Theory.
While it is said to "accumulate profits steadily",
this expression is not good with a trading method based on Prospect Theory.
How about in terms of fund management?
When the damage to assets reaches this point, the probability of bankruptcy is not zero.
In other words, the inevitable consequence of mathematically going bankrupt at some point is waiting.
When the damage to assets reaches this point, the probability of bankruptcy is not zero.
In other words, the inevitable consequence of mathematically going bankrupt at some point is waiting.
in order to truly avoid actions based on this Prospect Theory,
a two-step process is necessary.
a two-step process is necessary.
As a first step, we understand the inevitable consequence of bankruptcy through reasoning.
As a second step, we train not to conduct actual trades.
As a second step, we train not to conduct actual trades.
"If prospect theory is always a losing strategy, shouldn't we do the opposite?"
This observation is very sharp.
In other words, it means aiming for 'small loss, large gain'.
This observation is very sharp.
In other words, it means aiming for 'small loss, large gain'.
In the case of 'small loss, large gain', we narrow the stop-loss range and extend the profit as much as possible.
(In reality, the profit is locked in with a range 2-3 times the stop-loss range.)
To reduce the bankruptcy probability to 0, the losses per trade are kept below 2% of the assets ratio.
(In reality, the profit is locked in with a range 2-3 times the stop-loss range.)
To reduce the bankruptcy probability to 0, the losses per trade are kept below 2% of the assets ratio.
And, what must not be forgotten is that the edge is what exists there.
A famous trader, Larry Williams,
With just a little edge,
By combining the rule of cutting losses short and letting profits run,
It is said that he was able to develop a "profitable" trading system overall.
With just a little edge,
By combining the rule of cutting losses short and letting profits run,
It is said that he was able to develop a "profitable" trading system overall.
One of the edges that goes well with cutting losses short and letting profits run is "trend following",
It is not an edge that is so difficult to discover.
However, practice is not easy.
Due to the low win rate of 30% to 40%,
mentally, it feels like a continuous string of losses, making it difficult to continue.
It is not an edge that is so difficult to discover.
However, practice is not easy.
Due to the low win rate of 30% to 40%,
mentally, it feels like a continuous string of losses, making it difficult to continue.
while trend following itself is not a difficult edge to discover,
deciding on trading rules still requires a fair amount of trial and error and verification.
deciding on trading rules still requires a fair amount of trial and error and verification.
and understanding the logic, followed by internalizing it in a two-stage process,
remains necessary here as well.
remains necessary here as well.
if there are those who have been engaging in trades with 'big' losses and 'small' gains
and feel like they can't win,
After reading this article, how about taking a moment to reflect.
and feel like they can't win,
After reading this article, how about taking a moment to reflect.
Reprinted from my own blog:
Disclaimer: Community is offered by Moomoo Technologies Inc. and is for educational purposes only.
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