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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What is a market edge, how do I find them, and how do I turn them into a viable strategy?

Simply put, a market edge is a technique or process that when repeated leaves you with profit above other traders, when allowed to play out over a reliable sample size.

An edge can come in many forms and does not have to be elaborate; Although these aren’t actionable strategies, patience is somewhat of an edge, as is confidence. The ability to execute a plan with unwavering perseverance is somewhat of an edge, as is having an indifference towards money. These defining characteristics allow a trader to progress beyond most other traders and achieve better than average results which over time, compound exponentially.

An edge also doesn’t have to be complex; Something as basic as [and this is a fictitious example] realising that over a very large sample size, every time you execute long when a 14-period RSI reaches an oversold reading of 15 on a H4 chart with a -1R stop and a +2R target, across 100 trades you come away profitable.

But, make sure you’re looking in the right places; Although simplicity can be extremely profitable, you’ll rarely find an edge by utilising a common indicator.

Let’s strip things back for a second and zoom out; A brokerage platform is a business and your broker aims to take your money, plain and simple. Why on earth would they provide advantages to you, the retail trader, to profit regularly and take money from them?

They don’t provide tools like the RSI, the MACD or the Williams% for example to aid you and there’s a reason why your average broker doesn’t supply you with market profile, a footprint chart, the volume weighted average price and so on, and that is because they’d love for you to trade using the same old indicators as every other struggling trader and in my opinion, they provide them to you to keep you busy losing money and going around in circles.

As Zach Hurwitz says in his Chat With Traders interview – “Retail indicators are designed to make new traders feel better. They’re there to help them feel like they know what they’re doing.”

But, to add balance to my above statement, many traders do of course use indicators such as the RSI and the MACD and profit using them, but it’s always useful to bare the above in mind.

So, how do you discover edges?

I discover edges by looking into and testing many, many different occurrences that I notice within the markets whether based on varying timeframe levels, open prices, close prices, contract rollovers, methodologies I’ve read of in books or online, or a combination of one or two of these things, and so on.

At one point I was having a coffee with a trader who mentioned that he’d noticed certain currency pairs rose towards the end of the week. This spiked my interest and, me being me, I spent the following few weeks looking into this, literally spending hours each day building spreadsheets on occurrences, the time that certain things took place, relative MAE and MFE calculations, asking what would the outcome be if I executed at ‘x’ time of day as opposed to ‘y’ time of day, what if I only aimed for a +1R target, what if I only aimed for a +2R target and so on, to see if I was able to capitalise on any potentially reoccurring happenings.

This is my process, I pay attention and simply investigate everything and anything. When I’ve collated data on a potential edge, if the setup or occurrence seems to be taking place regularly I test these with varying parameters [As mentioned above] and try to apply rules and in turn build a strategy. I then re-run the strategy to build a win-rate and to see if it provides profit across a reliable sample size. If it does, I have a profitable edge on my hands and, I begin trading it.

Unfortunately the aforementioned currency price rise wasn’t conclusive [In my investigation at least], but similar testing has led me to find extremely profitable edges [i.e. The $DAX and $GBPUSD edges I currently trade regularly].

Edges don’t have to be complex but they do have to be statistically proven to result in profit in order to provide the confidence needed to execute across a large sample size of trades. For example, I could explain one of my edges, but without showing you the data, the win-rate, the expectancy, the most profitable R-target to utilise etc, if you were to then execute the edge and you happened to begin trading at the start of a 3, 4 or 5 trade losing run I expect your conclusion would be that the edge doesn’t work, when in fact, had you traded the strategy with consistency and let the edge play out across a valid sample size, this would have resulted in profit.

When you repeatedly follow a proven process you experience satisfaction. Repetition builds self-trust and psychological capital which leads to confidence, and in the end, profit.

Following on from the above, an edge also has to fit your personality. If your edge is mechanical i.e. you execute, place a stop and a target and walk away, if this process leaves you anxious you’ll be lead to emotion and when this takes hold it will impact your decisions and you may find yourself checking the chart, closing trades early or making adjustments that aren’t part of your plan, rules or strategy therefore sabotaging your edge and in turn your results.

How can you know whether your current strategy provides an edge? If you have a concise and statistically-proven strategy in place and you’ve followed this with precision over a reliable sample size of trades [Ideally a minimum of 100 trades], in most cases you will come away with profit. If you don’t come away with profit, it may just be a case of fine-tuning your process and your next step would be to look back over the data gathered across your sample size [And again, you must have followed your plan with precision, or the data won’t be accurate and thus your edge is indeterminable] zeroing in on perhaps your MAE or MFE, your target and/or stop distance/s or your entries perhaps. A couple of small adjustments that allow you to take that extra R or those few extra pips per month builds an edge that lasts a lifetime and dramatically increases profitability.

Analysing this data is something I specialise in and have regularly helped traders with. Many traders have approached me with a solid plan and a valid strategy, but poor results. All it’s taken is for me to either fine-tune their edge, strategy or process and they’ve gone on to profit from the markets they trade soon after.

I could write thousands of words on uncovering, testing and building strategies around occurrences in the markets to generate an edge as it’s something I’m incredibly passionate about, but for now I’ll leave it there.

Thanks for reading and I hope you’ve taken value from the above.

If you’d like to know more, if you have any questions or if you’d like me to take a look at your data [Journal, trades taken, strategy or plan, etc] feel free to Email me. I’m always happy to chat.

…or if you’d like to join me in trading my strategies alongside me, click here.

  • Will.

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The Importance Of A Trading Plan

Today, as I opened up my charting software to check my open H4 swing positions as they roll over for the first time of the day at 08:00am, I noticed a long position I’m holding on $DAX that I hadn’t checked on Friday had shot off upwards from my 12596.4 entry point a few days earlier and was currently showing a just under +200 point open profit on the trade. Now, the reason that seeing this inspired this post in regards to the importance of a trading plan is because I’ve recently introduced a new day trading strategy that I intend to trade alongside my H4 swing strategy, and in the weekly plan I wrote last night [On a Sunday evening, pre-market open] I’d stated that I was going to let my current H4 swing positions give me an exit signal before closing them, and then move up from H4 to D1 to allow me to fit the new day trading strategy in without compromising the attention needed to manage the swing portfolio, as I know I’d struggle to trade both with the attention needed to maintain consistency.

So, back to this morning… I wake up to see the $DAX trade is doing exceedingly well and my first reaction is an emotional one, outside of my plan; “Wow I wasn’t expecting that. Maybe I should close this now, bank the profit, and it’ll mean more money in the pot for moving over to the D1 strategy. Maybe I should just close all of the open positions now whilst they’re in profit? What if they all turn around tomorrow and result in break-even trades, or worse, losses?”. All these Maybe’s, all these thoughts and questions, they’re all natural emotional responses and they’re all extremely dangerous if we want to profit as traders. Succumbing to them not only damages our data but it damages our account balance, over the long-term.

These emotional questions make sense on the surface, but closing that trade early would affect the data that following your process provides you with. If you follow your process, all of your data i.e. the outcome of the next 100 trades tells the truth about your strategy. If you open trades that don’t fit your criteria, or if you close trades early and snatch at profits, when you look back at your trade journal it won’t tell the truth and it doesn’t give an accurate picture of your strategies results and therefore it leaves you wondering if you were either lucky or unlucky, or whether your strategy truly is profitable.

Thankfully I’ve learned to identify thoughts like these and as soon as it occurred I stopped myself, minimised the chart and opened my journal. I re-read my plan, and I knew exactly what to do; Nothing! No action was required, for any of the open positions. I usually plan for the week every Sunday evening, and review the week every Saturday morning along with journaling every trade I enter as it’s opened noting why I opened the position, and as I exit, noting why I closed the position, etc. [If you aren’t already doing this, I’d definitely suggest it]. Had I not written a plan and planned for every outcome in advance, or had I not prepared for circumstances like these, I’d have grabbed at the profit in an instant. And hell, maybe on this occasion I’d have been right to do so, but in the long run it would have damaged my account balance and my data, and accurate data is crucial to success as a trader, whether you’re taking a mechanical or discretionary approach.

So, next time you find yourself in a similar situation, reacting with emotion instead of logic, I hope you’ll be able to stop yourself and realise that the thoughts that are being triggered are natural, but they’re extremely dangerous. When these situations arise; Turn to your plan. And of course, if you aren’t already writing a plan, doing so really is crucial and I’d suggest, dependant on your strategy, that you put one together before you begin each trading week. Reviewing this plan can also help you see better results in your trading and can help you identify mistakes you might be missing when trading live, missed setups and/or trades, incorrect entries and/or exits, and so on.

Your edge and building on this edge is your responsibility, no-one else’s.

  • Will.

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How To Really Deal With Losses

I see so much advice in regards to how to handle losing trades, such as; “Don’t take losses to heart”, “Learn to embrace losses”, “Let go of losses” and whilst this advice is all important, it doesn’t help a new trader whatsoever.

One thing that’s important to remember is, and let me use an analogy, “You can’t learn to walk without first falling a few times”. The same applies to learning to ride a bike, you have to fall off the bike to learn how to eventually stay on it, and when it comes to trading, unfortunately losing money is the only way to learn how not to lose money (And god knows, I’ve been there myself).

Most beginners will suffer a heavy loss at a point in their early trading careers by holding a losing trade until the pain is too much, then they’ll close out for a huge and both emotional and financially damaging loss. This is what it takes for most to learn not to hold a losing trade, and it’s the same with many other techniques, strategies, setups and elements of risk; Until you’ve tried them and learned the hard way what works and what doesn’t, in alignment with your personality, overall, you’ll lose money.

Money is personal, and naturally our mind wonders towards thinking about all the things we’ll spend our winnings on when we close winning trades, or worse, when we’re staring at an open P&L (Advice: Disable your P&L so you can’t see it whilst you’re actively trading or it will cause you to trade with emotion rather than logic. Trust me, I’ve been there) and the first step to solving this problem and removing our emotional attachment to profits and worse, open and unrealised profits, is to trade small.

Trade at a size so small you can happily place a trade and the outcome will not bother you whatsoever. Trade so small that 10 losses in a row doesn’t phase you. This is one of the most important keys in learning to trade, and one I wish someone told me at the start of my career. Start small and build up, because it’s not just your capital and your skillset you’ll be building, but also the mental ability to deal with losses which is priceless as a trader. As your account grows, each small incremental step forward will feel natural, not forced, and will give you the confidence needed to gradually up your size.

Suggested Risk:

Position sizing should revolve around risk. Typically, risking roughly 0.5% – 1% of your total account size per trade will enable you to make your way through the learning curve, keeping you in the game whilst you learn what works and what doesn’t. For example;

£5,000 account, 0.5% [£25] – 1% [£50] risked per trade.

At such a risk percentage, it’d take a consecutive run of 200 losses in a row to wipe you out at 0.5% r/p/t, or 100 losses in a row to wipe you out at 1% r/p/t. On a smaller account, say £1000, your risk may need to be slightly higher as you build the account, but trade as small as you can, again, to enable you to make your way through the learning curve.

Yes trading small is deflating, hell, even boring, but are you in this game to learn and trade long-term, or are you here to have some fun and empty your account? Those are the only two possible outcomes. You have two options; Start small, learn, grow, build your account and reap the rewards, or empty your account.

Don’t be the person who thinks; “All I need is a few ticks at £10 a point and I’ve made £100”, because that one time that price instantly goes against you, and doesn’t come back, might just be the end of your trading career, or at least your account.

To summarise;

– Trade so small that even an extreme of 10 consecutive losses won’t phase you. It’s rare but it can and will happen. Make sure you’re prepared, especially early on in your trading career before you’ve developed your mental edge.

– Hide your open P&L and ideally, unless you’re scalping, don’t monitor unrealised profit. It’s not your money until the trade is closed.

– Think longevity over quick profits.

I hope this helps, and if it does (or doesn’t), feel free to tweet me and let me know your thoughts.

  • Will.

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Understanding Every Action You Take As A Trader

Why do you have your chart/s setup the way you do? Why are you using that indicator, what role does it play within your strategy? Why do you have your $CL chart first-right and your $AUDNZD chart far-left? Why do you wait for a candle to close before entering or exiting a position? Why did you enter that last trade, what was the catalyst and, looking back, (Do you always look back and deeply, consciously analyse each action you take?) was it the right decision? If so, why? If not, why?

Following an hour spent in conversation with a trader I respect hugely yesterday, Zack Hurwitz (Of Sang Lucci and The VWAP),  not only did I learn a lot but I came away questioning my every action.

As an extremely analytical person, I keep stats on everything. My exact entries and exits, reasoning for both, analysis of this reasoning, a journal detailing my daily actions, structure and reminders of any mistakes I’ve made recently so I don’t make them again, stats on my most profitable days and months and on the exact times of day that my winning trades take place and are executed and closed, stats on my strategy’s MAE and MFE… The list is endless. I constantly strive for improvement in any way possible. I take my trading extremely seriously.

As Trader Dante put it in his ‘Fail Better‘ thread on Forex Factory;

“If you are still not making money trading, it is because something you are doing [is not] working”.

To succeed as a trader, you have to understand every single action and its relevance, execute ruthlessly and with precision, have full belief, know and understand probability (Remember, even a well-executed and well-planned trade can and will result in a loss), and manage risk to stay in the game.

I believe the first step to becoming and remaining consistently profitable is;

Understanding every action you take as a trader.

  • Will.

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