Stage 3
51 questions
Why can't a total loss be made up with high returns?
Because returns multiply. A factor of zero makes the whole product zero.
What is an absorbing state?
A state from which there's no way back, here the total loss.
Can a strategy with a positive expected value ruin you for certain?
Yes, if over time it leads to total loss or very deep losses often enough.
What exactly does the one percent rule limit?
The maximum loss of a position, not the money put in.
Why use only a fraction of the Kelly stake?
Because win rate and payoff ratio are only estimated and usually overestimated.
Why isn't the rule per position enough?
Because related positions move at the same time and their risk almost adds up.
What happens if you set the stop tight so the position gets bigger?
The position will very likely be stopped out by quite normal swings.
What is risk measured by with leveraged products?
By the full value of the position, not by the collateral deposited.
What win rate does a three to one ratio need to break even?
25 percent, because 1 divided by (1 plus 3) is 0.25.
Why doesn't a higher price target automatically make a strategy better?
Because distant targets are reached less often and the win rate falls accordingly.
Why is the actual ratio below the planned one?
Because profits are often taken too early and losses can be bigger due to slippage and price gaps.
How do you calculate the expected value of a trade?
Win rate times average gain minus failure rate times average loss, both after costs.
What happens with a negative expected value if you trade more often?
The loss comes faster. Trading more only amplifies what's happening anyway.
Why aren't thirty trades enough to go on?
Because the estimate only gets more precise slowly, roughly with the square root of the number of trades. The true win rate can still be far off.
Why does the recovery needed grow so strongly?
Because the gain is applied to the shrunken sum. As the loss approaches a hundred percent, the gain needed goes to infinity.
How should you read the biggest drawdown so far?
As the least that can happen in future, not as an upper limit.
Which risk can be diversified away and which can't?
The risk of individual companies disappears with more positions, the shared risk of the market remains.
Why do ten stocks from the same sector offer little diversification?
Because they move almost the same way. Bad news for the sector hits them all together.
What is a correlation breakdown?
In crises, risky investments suddenly move strongly together, so diversification is weakest exactly then.
At what price move is your stake gone at leverage 25?
At four percent, because 100 divided by 25 is 4.
Why does an account grow more slowly above a certain leverage?
Because swings grow with the square of the leverage, the expected gain only proportionally. The swings reduce the actual growth rate.
What happens to daily leveraged products in sideways markets?
They keep losing value, because the leverage is applied to the new level every day.
Why is the actual liquidation threshold closer to the entry than one divided by leverage?
Because maintenance margin, financing costs and fees are deducted on top.
What does an obligation to pay more mean?
That you can lose more than you put in and have to pay the rest.
How does a chain reaction of liquidations start?
Forced sales push the price down, so more positions reach their threshold and are closed too.
What do you own when you buy a CFD?
Nothing. You have a contract with the provider about paying a price difference.
Where does the loss rate in the advert come from?
From the provider itself. The regulator requires it to state the figure for its own retail clients.
What conflict of interest can there be?
If the provider holds the other side itself, your loss is its gain.
Why don't good resolutions hold in a crisis?
Because under uncertainty, time pressure and excitement, fast, feeling driven thinking wins.
What is the return gap for fund investors?
Investors earn less than their own fund because they buy after good times and sell after bad ones.
Why do automatic savings plans work?
Because they take away your option to act instead of asking you to master your feelings.
Why do you usually get in late with FOMO?
Because a move has to get big before it's noticed at all.
What's a simple remedy?
A fixed waiting period of about a week between wanting to buy and buying.
What does prospect theory say about losses?
People judge changes relative to a reference point, and losses weigh about twice as heavily as equal gains.
Why do people become more willing to take risks after losses?
Because the prospect of getting back to zero weighs more than the danger of losing even more.
Which question helps with a stock that's down?
Whether you'd buy it again today at this price.
Where does confirmation bias work?
In choosing sources, in weighing evidence and in memory.
What is a criterion for your own mistake?
An event fixed in advance by which you'd recognize that your idea was wrong.
What is a premortem?
You imagine the decision has failed and collect the most likely reasons beforehand.
Why is the revenge trade the opposite of what makes an account grow?
Because your stake should depend on your capital. After a loss it should go down, not up.
How much do trading costs matter if you trade a lot?
They grow with the number of trades and can eat a large part of the usual return on stocks.
Which rule protects you on bad days?
A fixed daily loss limit or a maximum number of trades, however you feel at the moment.
What is outcome bias?
Judging a decision by how it turned out rather than by how good it was.
Why do you have to write down your reasons before the outcome?
Because your memory of the reasons adjusts once you know how it turned out.
Which figure matters more than the win rate?
The expected value, plus the share of trades where you stuck to your rules.
Why are past losses no reason to carry on?
Because they're gone however you carry on. For the decision, only what you can expect in future counts.
Why doesn't a losing run alone prove a bad strategy?
Because it can also come from normal bad luck with a good strategy. What also matters is whether you stuck to your rules.
When is the question no longer a maths question?
When your sleep, relationships or work suffer from trading. Then a conversation and professional help are called for.