Random Walks and How They Destroy Trading Myths

Building on concepts from a previous article on the risk-reward relation in trading and how it corresponds to winrate. I’d like to explain with some concrete maths behind it — the market random walk.

Often when people are talking strategy, they oversimplify the relationship of risk-reward (RR) at outset, and strategy winrate.

I’ve previously seen people emphasising the importance of ‘only taking 2R setups’ and ignoring everything else. Reasons cited are bogus experiments such as randomly entering the market and you’ll come out ahead.

That is completely false.

You cannot enter market at random and come out ahead, just because the reward is double what you are risking.

Firstly, let me explain what a simple random walk is, broadly speaking.

‘A random walk is a mathematical object, known as a stochastic or random process, that describes a path that consists of a succession of random steps on some mathematical space such as the integers.’ [1]

Or in our case, random steps on the market.

Assumptions:

• Markets are completely binary — price can only move upwards or downwards (not sideways).
• Markets are random — we know that they aren’t in practice due to a multitude of exogenous factors.
• There are no other trading costs such as spread or commission (I wish).