Education

Trading Ideas: The odds of hitting depend on your goal

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Some people say that the probability of being wrong or right is 50% when deciding to close a trade with a preset benefit.

Unfortunately, in trading that is not so. If that rule were met, then trading would be much simpler than it really is. There are two crucial moments when making a trrade: the time of entry, of course, and the time of exit. While it may seem like the most complex thing to decide when to enter the market, you will quickly realize that what really sets the gaps in your trading is when you close your trading.

That you could already intuit in my last entry, but I am going to stop here in the complex world of the probabilities and the statistics, which are totally fundamental to trading. Do you really think that the chance to hit a trade is the same if you are looking for a $50 upside, $100, or if you are going to let the profits run? I hope your answer is a resounding no, and I’ll try to explain why.

It turns out that the market moves through sawtooth movements. That is, it makes small impulses in a concrete sense, followed by small corrective setbacks (known as pullbacks), before continuing to move in the direction marked by the market trend. Our trades must fit perfectly in that movement of the market.

Let  me illustrate with an example. It is possible that you take a long position when the price of a certain asset is $50. You have seen that the trend is up, and you want to buy at $50. Of course, you put your stop loss of $10 (ie if the price goes down to $40, you automatically quit that trade with a loss of $10). If it turns out that you have entered the high part of an impulse, it is quite possible that in the correction movement of the pullback, you leave that trade with loss if the price touches $40.

But as the price was simply making a correction, you look silly as the price reaches $35, only to return to follow the uptrend and rise up to $65. This would be an example of a bad entry, without a doubt. But I’m much more interested in talking about bad outcomes, or the different probabilities of being right or wrong depending on the benefit you are looking for.

I guess you know where I’m going. In effect, imagine that you enter at $50, with a fixed profit of $10. That is, as soon as the stock price hits $60, you close that trade with a profit of $10. You made a good entry, the price goes up to $72, and you have left that trade with your $10 profit. Great! But of course, you see that the price has reached up to $72 and you have gone out at $60. You missed out on winning $12. If you could go back in time, you would be more ambitious with the benefit in that trade.

Granted! You go back in time, you re-enter $50, but you will not settle for winning $10. This time you’re going to go for $30, like a champion. The price rises in its momentum, reaches $60…reaches $72…reaches $76…then starts to decline. $76… 72, 60, 50…and yes $40, your stop loss. Same trade as above, but you just came out with a $10 loss .

This is trading, and that is prices can go completely against the goal that you intend to achieve. The probability of making mistakes is not the same regardless of the objective. The shorter the target, the more likely you will be to hit on your trades, but the lower the profits on each of them. Maximizing the mathematical hope in trading refers precisely to that: being able to take trades with a probability of success and an associated profit that results in consistent earnings.

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