Understanding Probabilities, and Risk Balanced Alongside Return

A fundamental step forward for newer traders happens when they understand probabilities, and risk balanced with return. From experience, a solid understanding of both is usually a key turning point in a traders’ career. It certainly was in my own trading journey.

You see initially, when we experience a run of losing trades, as humans and inexperienced traders it’s completely natural to worry. We’re losing money, of course we aren’t going to be particularly happy. But in trading [as long as we have an edge] all we’re seeing is probability playing out in front of us.

Understanding this alone is a big step forward for a new trader.

Bottom line: We can experience a run of losses, in fact at times a large run of losses, and still come away profitable. How?

This is where the importance of knowing your strategies’ win-rate, or strike-rate, or win-rate-percentage comes in, and is crucial. Why? Because we can use the knowledge of our strike-rate to study, expand on, place and refine our targets.

Let’s say your strategy has a 30% strike-rate. It doesn’t sound like much, but I know an extremely profitable trader who’s strike-rate has never been above 40%, it’s just his losses are small [Rarely larger than -1R, only being larger when slippage occurs] and when he has a winning trade, it’ll either be a small winner or a big winner, and it’s that rare handful of big winners that make him profitable.

The largest winning trade he’s experienced in the last 6 years of his career is +32R, or +32 times the risk he took on the trade. In other words, a +3100% return on the risk he placed on the trade.

Think about this; He could have a terrible quarter, he could drawdown his account by -25R or -30R, and that one winning trade still leaves him profitable.

And let’s look at this the other way around; My GBPUSD strategy has a strike-rate above 75% which provides winning trades more often than losing trades, but these winning trades are small.

In balance, these winning trades may be small, but their consistency provides us with enough profit to easily withstand a run of losses. The most losses I’ve had in a row on the strategy in the last 10 months has been five -1R losses, and the most winning trades I’ve had in a row on the strategy in the last 10 months has been 8 +1R winners.

This is risk balanced with return. Let’s visualise what the above variation in strike-rate looks like alongside the probability of a run of losses;

PPI 135

Strike-rate-dependant; Are you managing risk with the level of efficiency required to make it through the inevitable string of losses that your strategy is going to yield?

As you can see, with a strike-rate even as high as 60%, statistically it’s not out of the question to expect to have [a fairly terrifying] 7 or more losses in a row at times. So, next time you have 5, 6 or 7 losses in a row, remember to put a focus on respecting probability as it plays out rather than throwing in the towel before the winning trade that you need comes along.

As long as your strategy is statistically proven to provide an edge, all you have to do is stick to your rules, stick with your process and allow probability to play out.

To conclude;

Know your strike-rate, and use this to your advantage. Have a low strike-rate? It’s essential that your winning trades are large, and your losses as small as possible, never exceeding your risk [-1R]. Have a high strike-rate? Assess the size of your winning trades in comparison to your losing trades and refine your target.

I hope this short blog post on probabilities, risk and return help at least one trader out there the way it did me when I first gained a real understanding of the two combined.

Good luck with your trading.

  • Will.


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