What Is an Edge — and How Do You Measure It

Let me start with a question that will reveal the truth about your trading:

"What is your trading system — can you describe it as concrete rules in 1 minute?"

If your answer is "well... I look at price action, look at indicators, look at support and resistance, then look at whether it seems worth entering" — that is not a system. That is a "feeling" wrapped in technical jargon.

A feeling changes every day, changes with your mood, with the news, with the trade you just lost — something that constantly changes cannot be measured, and something that cannot be measured cannot be improved.

What is an edge

An edge = a statistical advantage — the mathematical reason your system will make money in the long run.

An edge is not "I'm good," not "I can read the market" — an edge is a number.

You measure an edge with a formula called expectancy (the expected value per trade):

> Expectancy = (Win% × average win) − (Loss% × average loss)

If expectancy is positive = the system has an edge = the more you trade, the more you profit (in the long run) If expectancy is negative = the system has no edge = the more you trade, the more you lose

A calculation example:

System A: Win 40%, average win 2R, average loss 1R Expectancy = (0.40 × 2) − (0.60 × 1) = 0.80 − 0.60 = +0.20R per trade

That means — every trade you open, on average you gain +0.20R · 100 trades = +20R

System B: Win 70%, win 1R, loss 1R Expectancy = (0.70 × 1) − (0.30 × 1) = +0.40R per trade

An important lesson — a high win rate does not mean a better system

Look at System C: Win 90%, win 0.5R, loss 5R (small wins often, the occasional brutal loss) Expectancy = (0.90 × 0.5) − (0.10 × 5) = 0.45 − 0.50 = −0.05R

System C wins 90% but its expectancy is negative — the more you trade the more you go broke.

This is the trap that kills a great many traders — they are proud of their "90% win rate" without knowing the system is leading them off a cliff.

3 numbers that define your edge: 1. Win rate — what % do you win 2. Average win (R) — when you win, how many times your risk do you make 3. Average loss (R) — when you lose, how many times your risk do you lose

If you do not know these 3 numbers for your own system — you do not know whether you have an edge — you are trading on hope.

The goal of this ebook:

To give you a real "system" — a system that: - Is written as concrete rules (Chapter 2) - Is proven with numbers to have an edge (Chapter 3 — backtest) - Is tested in the live market before you risk money (Chapter 4 — forward test) - Is improved without fooling yourself (Chapter 5 — optimization)

> A beginner changes systems every month, because he has no real system to hold on to · a professional uses one system for years, because he has the "numbers" that tell him it has an edge

From this chapter on — we will build those "numbers" together