Negative expectancy, in crypto investing and smart trading, describes a trading system or strategy where the average long-term outcome of each trade, when considering both winning and losing trades and their respective probabilities, is a net loss. Strategies with negative expectancy are unsustainable over time.
Mechanism
The mechanism of negative expectancy arises from an imbalance between the average profit of winning trades and the average loss of losing trades, weighted by their frequencies. For instance, a strategy might have many small wins but occasional, significantly larger losses, or simply an unfavorable win rate combined with a poor risk-reward ratio. Market microstructure, transaction costs, and slippage can exacerbate this effect in volatile crypto markets.
Methodology
Identifying and rectifying negative expectancy involves rigorous backtesting and forward testing of trading algorithms against historical and real-time market data. The methodology includes detailed performance metrics analysis, focusing on average profit per trade, average loss per trade, and win rate. Strategic adjustments involve optimizing entry/exit criteria, improving risk management rules to cut losses quickly, or selecting higher probability trade setups to shift the statistical advantage towards a positive expected value.
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