DailyFX Tips & Picks: You can be wrong half of the time and still profitable
HOW IS this possible and how can you leverage this? Well, if you gain 2 per cent of your account every time you book a gain and only loss 1 per cent on your bad trades, you will still be ahead.
You will on average take two steps forward when gaining and only take one step back when losing. While it’s quite a straight forward concept, the retail trader prefers doing the opposite; when they win the gains are small and when they lose, their losses will be far greater than their gains.
Studies placing random positions show that the return is usually higher when the risk-reward ratio is positive. It means that when you look to make more than the risk, you are undertaking. We also know that traders will on average lose two times their average gain. This is something we want to avoid.
So next time you trade and you know what your maximum loss is, ask yourself: is it possible to actually reach my profit target? If so, how much do I stand to make? If you stand to make at least what you are risking, then it's considered to be a satisfactory trade. If you can you make two times the risk, then it’s even better.
So forget about the Holy Grail of trading. It does not exist. Instead, look for setups with good risk-reward ratios and decent likelihood of playing out as expected. Trade only once and you will not notice any major difference. Trade many times with a 50 per cent edge and risk reward ratio of two times, and your results will look better than the average trader.
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Alejandro Zambrano is a currency analyst at DailyFX. He leads DailyFX's Premium Educational Seminars – http://bit.ly/PremiumEDU
Azambrano@dailyfx.com
Twitter: @AlejandroDFX