Probability and maximazing EV discussion

[eventive]

Fellow traders,

I like to start a discussion about probability and maximazing your expected value in a certain situation.

See attached chart, we are short 1 contract on 38 (level 1). Our stop is 4 ticks. Question is which target we are going to use, target 2 on 31 for a profit of 7 ticks or target 3 on 22 for a possible profit of 16 ticks.

What is the relationship of probabilities of the two targets and how do we determine them?

 

[eventive]

Well segutor, that depends on the probability of hitting that larger target. For instance, it is better to have a 30% chance on a profit of 7 ticks, than a 10% chance on 16 ticks.

 

[ordinaryguy76]

I believe the concept is flawed. How can you calculate probability of targets ? Computer says "no" - too many variables.

 

[eventive]

ordinaryguy76, the question is not the exact probability of the targets, but the relationship between them.

We took the trade believing it had a positive expected value, but with what target do we maximize our potential profit?

There are indeed far too many variables to calculate an exact probability, but which target do we pick when caught in a trade like this and more importantly why?

 

[ordinaryguy76]

You can try a different approach - close 50% of the trade on Target 1, set stop loss for the rest to b/e and target to Taget 2.

 

[eventive]

Difficult: "we are short 1 contract on 38"

 

[eventive]

I think the interesting part of the question is that let's say we have entered a trade in which we have positive EV. How do we choose the best target to maximize this EV. Eventually a target can be selected with which our initial edge would be lost, for instance a stop of 4 ticks and a target of 50 ticks.

What I think is interesting is if there are objective ways to maximize our EV. And what is the borderline in which we make a +EV trade a -EV.