Short term traders can actually make money if their winning percentage is only 50% – IF they pay attention to the basic arithmetic of trading.

Trade only when the potential profit is at least two times the risk – and preferably three or higher.

Be realistic about the risk – in trading futures it is hard not to risk about 4 ticks in many markets. The reason is simple arithmetic – you are automatically down 1 tick when you enter the market (plus commissions) as a result of the bid/ ask spread –and price may move a tick or two against you trade before turning in your direction.

Keep in mind that you are not likely to routinely get more than 80% of a move (we call moves oscillations). Therefore, if the price oscillations on the chart you use to construct your trade are 10 ticks your maximum expected profit is 8 ticks. Risking 4 ticks means you are at the minimum risk/reward ratio. Taking such a trade occasionally is okay if you pay close attention to your trade – but as a routine practice it is not desirable. You can work hard and still not make any money – unless your win/loss is greater than 50%.

Think about the basic arithmetic of trading – and try to elevate your trading as far above the minimums as possible.

TBL is oriented to trades that provide more reward versus risk – and properly executed – may produce a winning percentage greater than 50%.

Assuming the above numbers are applied, look at the results for 100 trades (note that we are ignoring commissions in this analysis, but they are paid on all trades – whether you make a profit or take a loss – our commission rate is $5.00 per round turn so the first example with “0” trading units net profit would actually be a loss of $500.00):

Risk/reward ratio 1 and winning percentage 50 % – Net profit = 0 trading units

Risk/reward ratio 2 and winning percentage 50 % – Net profit = 50 trading units

Risk/reward ratio 3 and winning percentage 50 % – Net profit = 100 trading units

Risk/reward ratio 2 and winning percentage 60 % – Net profit = 80 trading units

Risk/reward ratio 2 and winning percentage 70 % – Net profit = 110 trading units

Risk/reward ratio 3 and winning percentage 60 % – Net profit = 140 trading units

Risk/reward ratio 3 and winning percentage 70 % – Net profit = 180 trading units

Obviously, a small improvement in either risk/reward ratio or winning percentage can make a significant difference in net profit.

Multiplying the trading unit count by the appropriate value for the futures market you trade will give you the dollar value for each above scenario. For example, US bonds (our personal favorite market) has a tick value of $31.25 per contract (or trading unit). The widely traded E-mini has a tick value of $12.50.

FOREX is generally comparable, but the calculations are much more complex due to the fact that trades are calculated in pips and the number of pips per tick varies considerably depending on the market, and the spread is dependent on your broker.

Pay attention to the arithmetic – and tweak your system to take advantage of the fact that small improvements can make really big differences in your net profit.

We talk a lot about this in See the Music of the Market, our eBook describing our trading methods – get it at www.tradingbetweenthelines.com.

 

Leave a Reply

Your email address will not be published. Required fields are marked *

Comments Protected by WP-SpamShield Spam Blocker

See the Music of the Market

The unique trading method that is Trading Between the Lines