BarroMetrics Views: Left Brain Thinking II
Thanks to all who left comments.
If I were answering the question, I’d split my answer into two parts:
- A risk management phase, then
- A trade management.
To understand why I have done the split, it’s important to remember the function of the second third: it’s function is to deliver the method’s core profits.
The dilemma we face is: given our win rate, if we take profits too early, then in the long run, we’ll have a negative expectancy return; if we look to take profits too late, there may be no profits to speak of.
So, to find our way out the gordian knot, we’ll turn to Expectancy Ratio, a cousin of our friend, Expectancy Return. (NB: The link has an explanation on use of the Expectancy Ratio, and shows the formula).
Figure 1 shows the Expectancy Ratio, and the expectancy data of two traders. Their results are identical except for their win rate. Both traders are looking for a 20% ROI. (For our purposes we can ignore the columns in green),
Now, let’s apply the the Expectancy Ratio to a mock situation where the AUDUSD has made a low at .8034, and is currently trading at .8090. The price target for the second third is .8022. The question is should the traders take profits now, or should they look to manage the trade?
Based on Figure 1, Trader A can look to manage the trade; Trader B needs to exit.
Tomorrow we’ll look at why I say this.