How high are your chances of a profitable trade?

In the aspect of evaluating the specific risks involved with a proposed trade, a lot of traders only focus on the ratio of risk-reward. However, this piece of information is deemed to be pointless if you do not include probability in the equation. In order to evaluate the probability of success of a particular trading strategy, we must begin by properly setting an accurate, straight-forward definition for the trade setup. This is crucial to be able to spot the trade setup trading with real money on a real-time basis. Afterwards, if the setup had already been given precise definition, it must undergo a series of tests to check if the probability of success is far greater than that of failure. This is often termed as ‘Success Ratio’. To get this ratio, you must divide the total number of trades that were positively profitable by the total number of trades made. Then, get the percentage by multiplying the answer by 100. The answer is your success ratio.

What is Risk-Reward ratio?

So we can find out the Risk-Reward ratio, we must first know the success ratio, which had been discussed in 10.7., and the Sharpe ratio which is the average amount of money made on profitable trades relative to the average amount of money lost on the others. To compute for the risk-reward ratio, simply divide the average amount of money gained on profitable trades by the combined figures of the average amount of money gained and lost, then multiply by 100.

What is your risk per trade?

Even if you can forecast the direction the market will take 99% of the time, this will be meaningless if you risk 100% of your capital on every single trade. Yes, you could accumulate a fortune; however, the chance that one day you will lose everything is terrifyingly high. Most traders will never end up risking more than 1% of their capital at any given one time.

Why should you place your Stop Loss orders?

Unless you are an experienced trading expert, you must always ensure that you set up a stop loss for every trade. By doing so, you will have a guarantee that all losses will be cut short depending on the parameters you set for your stop loss. You must also vary the number of shares or contracts to make certain that you remain within the risk per trade parameters defined in 10.9.