Chapter 1
Developing Positive Expectancy Models
In the case of an earthquake hitting Las Vegas, be sure to go straight to the keno lounge. Nothing ever gets hit there.
—An anonymous casino boss
There are some prerequisite elements that are common to all successful trading programs. This and the next two chapters that follow will cover such elements: This chapter is on developing positive expectancy trading models, the second on implementing robust risk management methodologies, and the third on trader discipline. Let's get started.
WHY TECHNICAL ANALYSIS HELPS
Technical analysis is perhaps the single most valuable tool used in the development of positive expectancy trading models. According to technicians, the reason that technical analysis helps in the development of such models is due to the notion that “price has memory.” What does this mean? It means that when crude oil traded at $40 a barrel in 1990, this linear, horizontal resistance area would again act as resistance when retested in 2003 (see Figure 1.1). This reality drives economists crazy because, according to economic theory, it makes absolutely no sense for crude oil to sell off at $40 a barrel in 2003, since the purchasing power of the U.S. dollar in 2003 is different from its purchasing power in 1990. Nevertheless, according to technical analysis, the selloff at $40 a barrel in 2003 made perfect sense because price has memory. Price has memory means that traders experienced pain, pleasure, and regret associated ...
