Notes on trading system design and the pursuit of automation
The Axiom of the Small Edge, 11/04/05
From 1997 to 2003 I was addicted to
optimal f.
Still, I spent 2003 studying money management and in 2005
came to cast it all away for a simpler vision based on an axiom and a postulate:
The Axiom of the Small Edge:
A trader's long run edge is smaller than he thinks; it is much
more akin to a card-counting blackjack player's edge of 1% due to variance,
ever-changing cycles, and fear-induced losses.
The Postulate of Trading the Small Edge:
Given The Axiom of the Small Edge, what really matters in money management
is that a trader always be prepared,
always be able to hold a position with a positive edge that goes against him,
and always be able to take the next trade:
Imagine
The worst trading day you've ever had.
The seconds ticking by, the disaster scenarios playing vividly out.
Imagine
The blackjack player.
His edge is 1% or 2 hands/100.
Imagine
The pressure.
Imagine
The public speaker.
Stammering, nervous, unpracticed and unprepared.
Imagine
The blackjack player, the public speaker and the trader as one.
Imagine
Once per month being unprepared: 12 hands
Once per quarter succumbing to the pressure: 4 hands
Once per quarter not taking the next trade, not betting the correct size: 4 hands
Imagine
The blackjack player giving up 20 hands to the house:
Imagine
His edge is now -18%
The blackjack player and the trader as one.
"His edge is now -18%."
The Axiom of the Small Edge and The Postulate of Trading the Small Edge
say that what really matters in money management
is that a trader always be prepared,
always be able to hold a position with a positive edge that goes against him,
and always be able to take the next trade.
Henry Carstens
Vertical Solutions
carstens@verticalsolutions.com
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