Resolving A Common Barrier To Trading Success

[Trading Tools]

Many new traders can easily get caught in the trap of focusing more on their winning percentage (accuracy) or entry setups, rather than having a balanced approach to their overall trading system, thereby limiting their trading success. There are many aspects to successful trading which are equally important and must not be neglected, including risk/reward ratio, trade management, money management, etc.

Another critical, yet often overlooked aspect is, knowing the system you’re trading actually has a positive edge/positive expectancy (please note a positive edge is not simply having an accuracy rate greater than 50%).

Remember trading is an odds-based endeavour and traders are continually challenged by the prospect of making decisions in the face of uncertainty. As a trader, we must therefore place our trades based on a trading plan/system which has a proven edge (positive expectancy) and learn to think in terms of probabilities.
The importance of this statement must not be underestimated!

However every day, many traders put their hard earned money into the markets WITHOUT even knowing their system truly has a positive expectancy or worse still, not even trading to a documented and properly back tested trading system/plan.
This is a clear barrier to your trading success!

Trading is a business of dealing with probabilities, not certainties, and traders must train themselves to think in terms of probability for a very important reason:
Individual trades are not predictable. However, we can achieve a level of predictability in the outcome of a series of trades when you have an edge.

Mark Douglas (in his book, “Trading in the Zone”), calls this….
Paradox: Random Outcome, Consistent Results

It’s the ability to believe in the unpredictability of the game at the micro level and simultaneously believe in the predictability of the game at the macro level that makes a trader effective and successful at what they do.

”” Mark Douglas ””

So, how do you make the probabilities work for you?
Answer: Trade ONLY When You Have A Positive Edge !

But what does this actually mean?

Ask yourself the following question…

“What is my System Expectancy, also referred to as your 'Trading Edge' (average $ return per trade) for the trades I’m currently placing in the market“?

If you’re unable to answer this question, this may be a key barrier to your trading success and indicates that you are either:

1. Not recording your trading results at all,
2. Not analysing the results of your recorded trades, or
3. Are unsure how to calculate these values

In any case you need to take action in order to track your trades and analyse your results…

ACTION: Consider creating your own Excel spreadsheet to record your trade results, or using an existing trading journal product such as “Trading Journal Spreadsheet ®”
http://www.GlobalTradingTools.com/software/trading-journal-spreadsheet/

If creating your own spreadsheet but unsure how to calculate the expectancy of your trading plan, below is the formula:
Expectancy ($ per trade) = (Win% x Ave Win) – (Loss% x Ave Loss)

This expectancy value tells the trader how much money they would expect to win on average, per trade, however, to get a clear picture of your system expectancy you really need to aim for a minimum of 100 trades, but the more the better. Use a product such as NinjaTraders Market Replay to speed up the initial back testing of your plan, however after completing initial back testing, you then need to trade your system in a demo or simulation account to confirm you’re able to replicate the back tested results on live markets.

Only after these steps have been successfully completed, should you then consider trading in a live account (using your own capital), starting with small trade sizes.

An example:
If you have an accuracy rate of 55% (Win%), with your Ave Win being $280 and your Ave Loss being $140 …

Step 1:
We have a 55% probability of winning $280 and therefore, a 45% probability of losing $140

Step 2:
Expectancy ($ per trade) = (Win% x Ave Win) – (Loss% x Ave Loss), therefore …
= (55% x $280) – (45% x $140)
= 154 – 63
Expectancy ($ per trade) = + $91

If these were your trading statistics over a large sample size then your system would certainly have a positive expectancy, and therefore a positive edge.

If the trader of the above figures placed 100 trades (applying their trading plan with consistency and discipline) they would expect, on average, to make approximately $9,100 over 100 trades.

The real results of course will not be exactly the same (perhaps a little more or a little less) however if the edge that produced the above system statistics was applied by the trader consistently and with discipline, then over a 100 trade sample, they would expect, on average, to earn around $9,100.00

If however, the trader does not apply their edge with consistency and discipline, for example by taking “ad hoc” trades, entering earlier than defined triggers, not following trade management rules or failure to hold to targets while the premise for the trade is still intact, then it is extremely unlikely the trader will be consistently profitable over the long run…. which after all is what we’re really aiming to achieve.

Key points to remember:

• Ensure you have a documented AND back-tested trading plan which shows a clear positive expectancy over a large number of trades
• To get a clear picture of your system expectancy you really need to aim for a minimum of 100 trades, however the more the better.
• If your trading plan does not show clear positive expectancy then no amount of trading psychology, or anything else for that matter, will help in the long run… remember this is an odds based industry.
• Trade your trading plan/system with consistency and discipline.

Trade ONLY when you have an identifiable, proven positive edge!