V.10:7 (316-319): The Theory Of Runs by Robert P. Rotella

V.10:7 (316-319): The Theory Of Runs by Robert P. Rotella
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The Theory Of Runs by Robert P. Rotella

Are you the kind of trader who assumes that everything will go your way, only to be hit with a string of disastrous losses? Or are you the kind of trader who assumes that the worst scenario is the most likely one, only to find that you could have done a lot better with a much less fatalistic attitude? What are the chances of a series of bad trades occurring, anyway? In an excerpt from his Elements of Successful Trading, published by the New York Institute of Finance, Robert P. Rotella explains the theory of runs.

What are the chances of a series of bad trades occurring? Some traders ignore the possibility that they could get hit with one. Many others answer the question fatalistically with Murphy's Law "Anything that can go wrong will go wrong." Although this is a pessimistic way of viewing the problem, it's probably a good start, especially when it comes to trading. Let us look at what the possibilities are of any series of events occurring.

First, we need to know what the possibility of one event is to determine the chance of a series of the same events. If a coin is flipped, the chance of a tail or head appearing is one in two, or 50% . What are the chances of flipping two tails in a row? The probability of a series of events happening is the product of the probability of each independent event occurring. The equation to determine the chances of a series of independent events occurring is:

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