Observing Expected Returns Under a Magnifying Glass - Cryptocurrency Digital Asset Exchange Platform

Expected return is defined by the formula:

Expected Return = PW × AW - PL × AL,

where PW is the probability of profit in a single trade,

PL is the probability of loss in a single trade,

AW is the average profit amount,

AL is the average loss amount.

Suppose you want to participate in a game,

A bag contains 60 blue balls and 40 red balls,

Drawing a blue ball earns $1,

Drawing a red ball loses $1.

After each draw, the ball is put back into the bag.

The expected return of this game = 0.6×1 - 0.4×1 = 0.2,

The expected return is 20 cents,

which means after many plays, each draw can on average net you 20 cents.

Of course,

this does not mean you will win every time.

In fact,

in practical experiments,

it is very likely to have a streak of 10 consecutive losses in 1000 rounds.

But after 1000 rounds,

you might net a profit of $200.

Trading or investing in the market is even more complex,

Suppose the bag contains 100 balls,

with 7 different colors: 50 black balls with a return of -1,

10 blue balls with a return of -2,

4 red balls with a return of -3,

20 green balls with a return of 1,

10 white balls with a return of 5,

3 yellow balls with a return of 10,

3 transparent balls with a return of 20.

Again, balls are drawn and then replaced.

Note,

the probability of winning this game is only 36%,

Do you still want to play?

Using the expected return formula, it can be calculated that,

the expected return of this game is 0.78,

which means you net an average of 78 cents for every $1 wagered.

Through these two examples,

you should have learned a very important point.

Most people are looking for high win-rate trading games,

However, in the first example,

you have a 60% win rate,

but only a 20-cent expected return; whereas in the second example,

although the win rate is only 36%,

the expected return is 78 cents.

Note,

the most critical factor in the system is not the win rate,

but the expected return.

It is necessary to emphasize here,

Factors 5-6 are very important for your profitability.

Only by adjusting your position size wisely according to your capital,

can you achieve your long-term expected return over multiple system iterations.

Remember,

the position size in a given trade must be low enough to realize the long-term expected return after multiple system cycles.

Another factor—the frequency of playing the game,

also affects the total final return.

You must multiply the expected return by the number of times you can play,

which is the total return you can obtain.

Why have so many people, over many years, encountered setbacks when predicting market or stock trends? They base their prediction algorithms on past data,

sometimes even believing they will repeat.

However,

such impatient predictions can even lead to the loss of all your capital.

Because you might be using a trading method with a 90% win rate but still lose all your money!

There is a very strong psychological bias in our investments to want to be correct.

This bias severely ignores the overall goal of our methods, which is to profit,

or it hinders us from reaching our true potential profit.

Most people have an overwhelming desire to control the market,

Therefore,

in the end, the market controls them.

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