Forex Trading Tips: Hitting High Probability and High Profit

Hitting High Probability and High Profit

Contrary to popular belief, getting the correct direction in trading is easier than most people think. “The euro will go up”. “The Dow will go down” etc. The finance channels are full of gurus who make those broad statements and then claim credit when they are eventually proven right. Unless you find yourself in a strong one way market, the nature of trading dictates that you will be right irrespective of whether you are bull or a bear since price will typically retrace its moves.

The truly difficult part of trading is getting amplitude right. The euro may indeed rally after you make a trade, but only for 15 points or so before turning around and going the other way. The old hackneyed platitude of trading is to cut your losses short and let your profits run, but how can you let your profits run if you don’t know if the trade is good for 15 points or for 150? The truth is that you don’t and anyone who tells you otherwise is lying. Trading above all is the art of managing probabilities, which in simple English means the discipline of controlling your mistakes. A trader is like a traveler in a maze who tries many different paths, fails, retraces his steps and finally finds the true path to the exit. Trading like maze walking is essentially a probative activity.

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Given the uncertain nature of the game traders always face a dual choice -- high probability or high profit. The shorter you set your amplitude goals the higher the probability that you will achieve your target. On the other hand if your amplitude is long than you stand chance of making high profits albeit at a much lower probability rate. In short in trading there is always a tradeoff between high probability and high profit. But can you try to achieve both? In reality no. If there was system that was both high profit and high probability, the owner would be a trillionaire since he would in effect be able to corner the market. There is however a compromise solution that we practice at BK that tries to at least capture some of the high profit potential while at same time trying to keep a high probability posture.

By trading two units we structure every trade in such a way that we can try to bank at least some high probability profits with a short target and then neutralize our risk and let the second unit run hopping to hit a high profit trade. In the end the average blended profit from the two units still results in smaller wins than losses, but because of the high probability nature of the first half of the trade, the losing trades tend to be less common. Furthermore, the few times that the high profit part of the trade does hit its target, it provides the alpha (the excess returns) that we seek.

Many traders wonder if this approach can be traded on one unit instead of two, lowering the risk level of the overall trade. The answer Is yes, but there is a tradeoff to be made. The retrace nature of financial markets will result in many one unit trades being made for scratch and scratch trades are a little like kissing your sister. After taking the trouble to commit to a position, few traders like the idea of walking away with nothing at the end of the trade. That’s why trading strategies that are mathematically optimal are often psychologically unpalatable and since trading is such an emotional enterprise the two unit approach tends to work better.

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