Law of Large Numbers

This note includes the following topics:

  • Law of Large Numbers(L.L.N)
  • Implication of L.L.N on Trading
  • Statements to AVOID

Law of Large Numbers(L.L.N)

  • L.L.N states that the average of the results obtained from a large number of trials should be close to the expected value.
    • It will tend to be closer as more trials are performed.
  • That’s how Casinos make money after people place a large number of bets over time.

Implication of L.L.N on Trading

  • To determine if a trading strategy has an EDGE, you need a LARGE sample size of trades.
  • Minimum number of trades to judge a potential EDGE: >40 trades
    • You CANNOT judge a strategy whether it works or not based on a few trades.
    • You should NOT seek someone else’s opinion on a particular stock since you don’t know if the feedback is based on a positive expectancy system.

Statements to AVOID

All the following statements fail the Law of Large Numbers theorem (not enough sample size):

  • I tried this strategy for a month and all five trades were losers. I will QUIT.
  • The man who predicted a recession is now saying that…
  • The Yield Curve Inversion predicted the 1929 recession.

Leave a Reply

Your email address will not be published. Required fields are marked *