Understand the probabilities in trading
In this blog I want to try to explain you, why understanding the probabilities in FOREX trading is so important. In general trading business is not much different from ‘owning a casino’. All casino owners know their probability numbers and know that statistics are on their side. In order to be profitable in trading you must think like a casino owner. You must know your statistics and know your winning probability over a large number of trades. To give you a good example on how probability can affect your trading results, I’ve coded a simple trade simulator.
So let’s assume you have a $10000 account and you already have a strategy or system that gives you 60% winning edge (following a normal distribution). You will not risk more than $100 per trade (1% of your $10000 balance) and you will place your orders with TakeProfit and StopLoss equal to 10pips (equal to $100 with 1 Lot size). Furthermore let’s assume your broker has a fixed spread of 1pips. Ok, now let’s go and hit ‘Simulate trades’ button several times to see what are the possible outcomes w.r.t your end balance after 1000 trades (1=winning trade; 0=losing trade).
As you can see in this configuration the end balance can be something between: $25200 and $14800, but on average you will be always in profit! So now let’s change only one parameter, let’s assume someone is trading the same system on a different broker with a different spread of 3pips instead of 1pip. Let’s repeat our experiment and see what will happen.
So after hitting the ‘Simulate trades’ button several times it becomes clear that in this configuration we will most probably lose our money! The very same system that is used in the first example will lead to a total dissaster when used on a different broker that is using only ‘slightly’ larger spread of 3pips.
So I hope, that after reading this, you wil now understand why you should know your own numbers in your own configuration before starting live trading or blaming EA’s or systems and complaining that they do not work;) Remeber this one thing: the key to success is in your own numbers!
Chris and Coensio team.