What is Z-Score in Trading? In simple terms, Z-score measures the distance between an observed outcome (like a win or loss) and the average result in a set of data. In the context of trading, this data set typically represents your wins and losses over time. The Z-score is most commonly found in the range of -3 to +3, with higher scores indicating a greater probability of consecutive wins followed by losses, and lower scores representing more random, unpredictable outcomes. A high Z-score suggests that your trading strategy is likely to go through a series of wins, followed by a series of losses. This information can help you adjust your capital allocation and manage risk better. Conversely, a low Z-score points to a more chaotic trading environment where wins and losses alternate with little predictability. How Z-Score Can Improve Your Trading Decisions 1 • Understanding Random vs. Strategic Trading Traders who act without a strategy tend to experience unpredictable results — one win here, one loss there. This type of trading is driven by randomness and typically has a low Z-score, meaning there is no clear pattern of consecutive wins or losses. On the other hand, traders who use strategic approaches — like the ones developed by SOFEX —tend to see more predictable outcomes. These strategies often have a higher Z-score, signaling that you can expect a string of wins, followed by a string of losses. 2 • Capital Management Based on Z-Score The Z-score provides crucial insights into when to adjust your capital. The general rule of thumb is: • After a streak of wins, reduce your capital. The Z-score indicates that a loss is likely to follow after a series of wins. • After a loss or streak of losses, increase your capital, as a win is statistically more likely to follow. For example, if you start with $1,000 and win multiple times in a row, your first instinct might be to increase your capital to $2,000 or even $3,000. However, this is where most traders make a critical mistake. Based on the Z-score model, it's better to decrease your capital after consecutive wins, as losses are statistically imminent. Conversely, increase your capital after a loss to benefit from the upcoming win streak. 3 • Avoid Overconfidence After Wins Traders often fall into the trap of increasing their stake after a series of wins, assuming that the market will continue to favor them. However, the Z-score suggests that after 3-5 wins, you should lower your risk and decrease the amount you're trading. By doing so, you protect your profits from the losses that typically follow a winning streak. 4 • How to Apply This in Practice Let’s walk through a typical trading scenario: You start with $1,000. You win multiple trades, so you might be tempted to increase your capital. However, if you understand the Z-score, you’ll know that after several wins, a loss is likely coming soon. Instead of increasing capital, reduce your stake, say, to $500 or $800. When the inevitable loss comes, you’ve minimized your risk. After this loss, you can now increase your capital back to $1,500 or $2,000, as the Z-score suggests that a win streak is more probable after a loss. By following this approach, you avoid major losses after a win streak, and you’re well-positioned to capitalize on the next string of wins. Key Takeaways for Traders • Z-score predicts patterns in trading, with high Z-scores indicating win streaks followed by losses, and low Z-scores indicating a more random, unpredictable pattern. • After consecutive wins, lower your capital to protect your profits, as losses are statistically likely to follow. • After consecutive losses, increase your capital to take advantage of the upcoming win streak. Managing your capital based on Z-score predictions allows you to minimize losses and maximize profits, even during market fluctuations. Final Thoughts Trading is as much about managing risk as it is about making profits. The Z-score strategy can help traders anticipate win and loss streaks, allowing them to adjust their capital allocation more effectively. By following this model, you can protect yourself from large losses and make smarter decisions about when to scale up or down your trades. In summary, to optimize your trading: • Lower capital after multiple wins to avoid large losses. • Increase capital after losses to take advantage of win streaks. Implementing these strategies based on the Z-score will not only improve your trading outcomes but also help you build long-term, sustainable profitability. This is of course coming from my experience. Thank you for reading!
I thought Z-score was just mean/standard deviation, and thus does not use autocorrelation, and thus can tell you nothing about when a loss is more likely to happen after a series of gains; or not. GAT PS oh look it's a naughty stealth vendor @Baron
My article has nothing to do with vending machines mate, and yes I develop strategies but what does that have to do with anything posted here. Read the article I have used as a source and educate yourself on Z-Score and statistics. PS oh look its a know-it-all who bullies new users @Baron
OK, and apologies if you think I am bullying you (but trust me - I do know about statistics), but consider the following two return streams: +1, +1, +1, +1, -1, -1, -1, -1 +1, -1, +1, -1, +1, -1, +1, -1 Both will have the same Z score, but the first has positive autocorrelation (positive returns tend to be followed by positive, and vice versa); the latter has negative (positive tends to be followed by negative). Your advice to Lower capital after multiple wins to avoid large losses will only make sense in the first case. The Z s-score tells you nothing about whether doing this makes sense or not. This is very stylised but different strategies do have different autocorrelation properties, and over different time periods. One of my blogposts "https://qoppac.blogspot.com/2015/11/random-data-evaluating-trading-equity.html" goes into more detail about this. GAT
Alright - Thank you for explaining I will read that. It looked agressive. Im not pushing anything on anyone Im in the process of learning and decided to share what I found about a few strategies by observation, then found it to be discussed by others and wanted to summarise. No hard feelings I hope.
Without entering in the Z-score debate... Point 4 comes straight out of Game Theory applied to gambling. In practice you never know when a winning streak is ending, you do know that after a loss has happened, but right in the moment where you are in the winning streak there is no way to know if the next attempt is going to be a loss. I don't think this way of managing sizes applies to trading, but more to games where the rules are set and the outcomes follow a defined set of variables. i.e card games. There are two many variables that apply to trading to be certain that "you are always playing the same game". I am sure that if you ask profitable traders for the variables they use to trade, you will end with different "games" on the same market. So applying this basic Z-score sizing is way too simplistic to get a calculated approach on a result. Just my two cents.