Probability and reward-to Risk Assessment -Traders Must Read

  • Never open a position without knowing the initial risk.
  • Define your profits and losses as a multiple of your initial risk (R-multiples).
  • Limit your losses to 1R or less.
  • Make sure your profits on the average are bigger than 1R.
  • Never take a trade unless the reward-to-risk ratio of that trade is at least 2:1 and perhaps even 3:1.
  • Your trading system is a distribution of R-multiples.
  • When you understand #6, you should be able to hear/see a description of a system and know the kind of R-multiple distribution it would generate.
  • The mean of that distribution is the expectancy, and it tells you what you’ll make on the average trade. It should be a positive number.
  • The mean, standard deviation, and number of trades determine the SQN score for your system.
  • Your SQN score tells you how easy it will be to meet your objectives using position sizing strategies. Other than that, your system has nothing to do with meeting your objectives.
  • Systems are usually named after their setups, which are usually based on some attempt to predict future prices. Prediction has nothing to do with trading well.
  • System performance has to do with controlling risk and managing the position through your exits.

All Type of Traders Are Trying To Catch Trend Only

  1. Long term trend followers are trying to be right about the long term trends in the markets they trade using mechanical systems.

  2. Buy and hold investors are trying to be right about the stock market indexes and mutual funds being in a long term trend over their lifetime. 

  3. Value investors believe that under priced stocks will reverse and trend higher over the long term based on the cheap price they are getting based on a companies fundamentals.

  4. Day traders are trying to capture the trend that happens in one day’s time frame.

  5. Swing traders bet that the trend reverses off support or resistance levels and give them a profit.

  6. Can Slim traders are trading the trend of a hot growth stock out of a base price range or cup with handle pattern

  7. Bear are betting that the trend reverses and something goes down in value and they make money.

  8. Call buyers are trying to capture an up trend, call sellers want to profit from a down trend.

  9. Put buyers are trying to capture a down trend, put buyers want to profit from an up trend.

  10. Traders buying long  option strangles are betting on a trend either way bigger than what is priced in, Strangle sellers are betting the trend will be less than what is priced in.

All trading methods are simply an effort at trend identification and capturing profits by entering at a high probability moment and exiting with profits in place.Being on the right side of the trend in your time frame is what a successful trading method is all about.