This is the transaction…
95% of traders don’t know what it takes to achieve a successful trading.
That’s why many traders have blown up their accounts.
So most traders will be in circles for years without showing results.
So, only 5% of traders will succeed in the long term.
So, what is needed to achieve a successful transaction? Is there anyone who is consistently profiting over the long term?
Risk of reward rate?
Transaction psychology?
Discipline?
No, that’s more than that, and that’s not what you think.
So let’s break this down.
The first thing you need to know is…
corner
Edge (also known as expectation) is something you do repeatedly with positive results.
For example, toss a coin:
- If it appears = you will win $2.
- If it comes on, tail = you lose $1.
Will you win or lose in the long run?
You will win. That’s because your victory size is greater than your loss. In other words, you have a positive edge (or otherwise called positive expectations).
So, what happens if that’s the opposite?
- If it appears = you will win $1
- If it comes up, tail = you lose 2 dollars
Will you win or lose in the long run?
You will lose. And you can see why. In this case, there is a negative edge (also known as negative expectation).
Next, let’s go into more detail to see if your trading system has an advantage…
How to objectively define edges
Mathematically, edges can be defined as:
e = (Victory % x Average Gain) – (Loss average loss %)
Don’t worry, this is not rocket science. Because even 12 years old can understand that.
Let me give you some examples so you can see how this works…
Example 1: Positive Edge (high win rate)
- Winning rate: 70%
- Average gain: $80
- Loss rate: 30%
- Average loss: $100
E = (0.7 x 80) – (0.3 x 100) = $26
This means you can earn an average of $26 per trade. So after 100 trades, you can expect to make around 26×100 = $2600.
Another example…
Example 2: Positive Edge (low victory rate)
- Winning rate: 40%
- Average gain: $200
- Loss rate: 60%
- Average loss: $100
E = (0.4 x 200) – (0.6 x 100) = $20
This means you can expect to earn an average of $20 per transaction.
And the last example…
Example 3: Negative Edge (high win rate)
- Winning rate: 70%
- Average gain: $10
- Loss rate: 30%
- Average loss: $100
E = (0.7 x 10) – (0.3 x 100) = – $23
This means you can expect to lose an average of $23 per transaction.
Example 4: Negative Edge (low win rate)
- Winning rate: 40%
- Average gain: $120
- Loss rate: 60%
- Average loss: $100
E = (0.4 x 120) – (0.6 x 100) = – $12
as you can see…
You can get a high win rate, but you still lose (Example 3)
You can have a favorable risk reward ratio, but you still lose (Example 4).
So every time I hear someone say…
“A profitable transaction is finding a minimum 1-2 risk reward ratio.”
If your win rate is too low, it’s nonsense because the 1-2 risk-to-reward ratio won’t save you.
This is the transaction:
That alone makes your victory rate or reward-to-reward ratio pointless. You need to combine both to know if there is an edge in your trading system.
Now, having an edge alone will not make you a profitable trader. You need it too…
Risk Management
Risk management protects the downsides no matter what happens (even if you lose 10 consecutive transactions).
Without it, even the winning trading system will fail.
This is what I mean…
Imagine having two traders, John and Sally.
- They have a trading account for $10,000
- They have a 50% victory
- They have an average risk-to-reward ratio of 1-3
- John takes the risk of $5,000 per trade
- Sally takes the risk of $100 per transaction
The results of the next 10 transactions are as follows…
Losing Losiewin win win win win win
This is the outcome for both traders…
John blows up his account (after losing two deals in a row).
Sally made a profit of $1,000 (calculation: -100 x 5 + 300 x 5 = $1,000).
Do you know what I mean?
This is the importance of risk management. Because it protects your downsides, allowing you to deploy your edge in the long run.
But that’s not the only…
Discipline
Discipline refers to following the rules of the trading system no matter what happens.
Even if you’re on vacation.
Even if you don’t feel good.
Even if you run into 10 losses in a row.
That’s because you never know the outcome of each trade. By skipping transactions, you avoid winning transactions that you can pay for many small losses that have been incurred before.
Let me give you an example…
Imagine the outcome of the following seven transactions:
Lose, win, win, win
As you can see, by following the rules, I ran into three losses. On the fourth trading opportunity, you decided to skip the trading as you think it’s likely to be a loser.
So, you skip the deal and it turns out to be a winner.
After that, a fifth trading opportunity appears, but the pain from recent losses is still raw and you don’t want to live it again. Therefore, you have decided to skip the transaction. And again, it turned out to be a winner.
Soon, the sixth trading opportunity will appear. You feel stuck because you don’t know whether to follow the system or skip a transaction.
You wonder yourself…
“Should I follow my rules?”
“But the recent victory must mean that losses are around the corner.”
“This means there’s a high chance that the next deal will be a loser.”
After being hesitant, you decided to skip the transaction again.
At this point, you will be disappointed in yourself by not following your rules and cherry-picking your deals based on your feelings, not knowing what you should do.
So I promise to receive the next transaction when the opportunity arises.
Eventually, the seventh opportunity appears and follows the rules.
Finally, you caught the winner! But you still lost money overall. That’s because your recent winner is not enough to cover your previous losses.
However, if you had the discipline to follow the rules rather than trading based on your feelings, you would have earned a net profit.
This is the transaction…
Consistent actions lead to consistent results. If you want to be a consistently profitable trader, you need to be consistent with your actions. That means being a disciplined trader.
Now you know what you need to be a consistently profitable trader. But even so…
Why do most traders fail and how to avoid it?
Here are three common reasons why traders fail…
- There is no risk management
- There is no edge
- There is no discipline
Let me explain why it happens and how it can be avoided…
There is no risk management
Most traders blow up their accounts because they don’t have risk management.
For some, they also don’t have any discipline or think about what they’re doing. So when combining these factors, it is a disaster recipe. This is how traders blow up multiple trading accounts.
So, what is the solution?
Risk management.
This concept is not difficult to learn and pays dividends to the remaining trading carriers.
If you want to learn about risk management in stock trading, check out this training…
