The Basics of Trading

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Old Jan 29, 2003, 1:53am   #21
 
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fingers crossed (I think I CRACKED it)
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Old Jan 29, 2003, 1:59am   #22
 
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colours are CR*P (I can cancel the WHIZZ KID now (lol)
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Old Jan 29, 2003, 2:51pm   #23
 
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Hello everybody, particularly Paul and Jonny T

I think your Risk/Reward calculation is a bit misleading. The obvious inference is that you can improve the ratio by either reducing your stop loss or increasing your target price. Either of these could result in disaster. A better way of looking at risk and reward is to include some assessment of the probability of the SL being breached and of the target being reached.

For example, you might conclude that, based on the figures you mentioned, the probability of 820p being breached was 20%, but increasing the SL to 850 would increase the probability to 50%. Similarly, it seems logical to assume that the higher you set your target price, the lower the probability of achieving that figure. At the price quoted by Paul (862p) you might assess that the probability of reaching 900p was 75%, but that would decline as the target price increased. You might conclude that the probability of reaching 1080 within a reasonable timescale was only 35%. This would give (for want of a better term) a Probability Ratio of 35/25 or 1.4.

In the figures I have given, the Probability Ratio for a target price of 900p with a SL of 820 (ie a small, quick profit) would be 3.75. If the SL was reduced to 850 the Probability Ratio would give a negative for a target of 1080 and a ratio of 1.5 for a target of 900p.

This approach gives a more realistic assessment of the risk involved, but does require an estimate of probability for the target and SL.

I put this suggestion forward for discussion.


John
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Old Jan 29, 2003, 4:32pm   #24
 
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Hi John,

Surely this depends on timescale?

I wasn't looking at a day or swing trade, more an intermediate trade.

I stand bu my guns.

As Bush is saying to Saddam
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Old Jan 29, 2003, 5:15pm   #25
 
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Hello JonnyT

Time is definitely another factor but maybe we're talking at cross purposes. My post was trying to introduce a method which gave a realistic estimate of the probability of a trade succeeding.

Your calculation seemed to imply, especially to someone without experience, that the probability of success in the trade is about 73% - and if you're getting that sort of success rate, can I shadow you? Mine implies a success rate of about 40%.

I've no doubt that your experience tells you the true probability of success and the Risk/Reward ratio as you define it is a useful tool, but it doesn't show the overall risk of a trade. Trader 333's post also introduces some caution by highlighting the percentage of successful trades.

John

PS - I lived in Ruddington until middle of last year. Small world - just what is the probability of that?
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Old Jan 29, 2003, 5:33pm   #26
 
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Hi John,

Very small world!

I agree the RR may fool a complete novice, but I'm sure I never meant to suggest or infer a 73% success rate.

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Old Jan 29, 2003, 8:17pm   #27
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Thank you FTSE B and all the others who replied.I have read all the responses to my question and am learning more and more about risk reward and hope to see more advice on the subject.
Im keen to learn more about this because it will help me to reduce my cr*p trading.I have been making too many mistakes and was thinking of packing it in.
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Old Jan 29, 2003, 8:40pm   #28
 
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Talking Re: The Basics of Trading

HI

I WOULD LIKE JUST TO DARE TO TELL YOU ,ALL THE EXPERTS, THIS IS SUPPOSE TO BE A BEGGINERS FIRST STEPS , AND I DID PROPOSE THE START OF THIS BOARD FOR A KIND OF FIRST REAL STEPS ON TRADING, I BELIEVE IN ALL THIS RISK/REWARDS, PROBALITY'S AND EVERTHING ELSE BUT HONESTLY FOR ME I AM STILL A LITTLE BIT BEHIND THAT POINT, AS ALSO THERE IS THE PROPER BOARD FOR YOU CHANGE ALL YOUR IDEAS,OPINIONS AND DOUGHTS IN A MORE ADVANCED LEVEL, WHICH I ALSO BELIEVE IS WHAT YOU REAL NEED...
PLEASE DON'T TAKE ME WRONG BUT I THINK WE ARE LOOSING A LITTLE THE " MEANING" OF WHY THIS THREAD STARTED...
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Old Jan 30, 2003, 12:26am   #29
 
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Decorum please

Please don't shout TC

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Old Jan 31, 2003, 8:21pm   #30
 
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The Secret to Trading

FTSE Beater started this thread Hi all

I thought it was time to show you the solution to trading. The hidden secret that will change your life forever, and this is it:




&nbsp &nbsp &nbsp &nbsp &nbsp &nbsp &nbsp &nbsp &nbsp &nbsp &nbsp &nbsp &nbsp &nbsp &nbsp &nbsp &nbsp &nbsp &nbsp &nbsp &nbsp &nbsp &nbsp &nbsp &nbsp &nbsp &nbsp &nbsp &nbsp &nbsp &nbsp &nbsp &nbsp &nbsp Click the image to open in full size.
MONEY MANAGEMENT,

Money management is king. In the land of the trader, money management has ruled and killed all the traders who don’t believe in it.

This is nothing new, but few new traders use money management wisely and get “killed” because of it. There is a myth among new traders that you HAVE to be right more times than wrong. This table is one that I’ve taken from “The Master Swing Trader” by Alan Farley:

<table border="1"> <tr><td>%Win</td><td>Trades</td><td>Avg Win</td><td>Avg Loss</td><td>Profit</td></tr> <tr><td>75%</td><td>100</td><td>£800</td><td>£2000</td><td>£10,000</td></tr> <tr><td>50%</td><td>100</td><td>£800</td><td>£600</td><td>£10,000</td></tr> <tr><td>25%</td><td>100</td><td>£800</td><td>£133</td><td>£10,000</td></tr> </table>

What the table shows is that to be profitable, or more profitable, you can either work on being right more often, or reducing the losses. Most new traders will let their losses run and run, which means the trades that follow must be right to claw back the money they have lost.

This is a table that Chris Manning displays, and it really shows the importance of cutting your losers

<table border="1"> <tr><td>% loss &nbsp &nbsp;</td><td>% gain needed<br>to break even</td></tr> <tr><td>10%</td><td>11%</td></tr> <tr><td>20%</td><td>25%</td></tr> <tr><td>50%</td><td>100%</td></tr><tr><td>80%</td><td>400%</td></tr> </table>

It shows that the higher the loss the significantly higher % gain it takes just to get back to square one.


The most effective way of controlling your trades is to look at the risk / reward ratio of the trade before you enter into it. This is done by setting a rough price target, and knowing the position of your STOP. From this you can then work out the risk / reward ratio, for example

Current price = 100
Target = 109
Stop = 97

Reward = 9 points
Risk = 3 points (including commission).
Giving a 3:1 ratio

Knowing where to place the stop is a difficult thing, but the rule of thumb is that the stop is placed at the point the chart tells you “you are incorrect” Most people (including myself) rarely take anything less than a 3:1 ratio, especially for stocks. A 3:1 ratio means that you only have to be right 25% of the time to break-even.

Once your in a trade one of 3 things can happen, Either your stop gets hit, the price moves sideways or the price moves into profit. The first 2 you can’t really do much about, but when a price moves into profit, then you move the stop to lock in some profit. This is an art form in itself.

The important thing is to make sure that at any one point, the risk should not be equal or greater than the reward. In the above example, if the price went to 105, and we didn’t move the stop we would have this scenario.

Current price = 105
Target = 109
Stop = 97

Reward = 4 points
Risk = 8 points
Giving a 1:2 ratio

This is where moving the stop to lock in profits really comes in. If we move the stop to 102, we lock in 2 points worth of profit and have the following risk / reward

Current price = 105
Target = 109
Stop = 102

Reward = 4 points
Risk = 3 points
Giving a 1.3:1 ratio, which is a lot better than the 1:2 ratio we had earlier.

Moving stops, and stops placement is very difficult, but I will hopefully find someway of explaining it next week.

If we have a look back at the chart of AAL from last week, we can see that at the close on the 24th January we would have had this risk profile.

Click the image to open in full size.

Current price = 874
Target = 930
Stop = 859

Reward = 56 points
Risk = 15 points
Giving a 3.73:1 ratio, which is good enough for me


The other aspect of money management is the stake size. I know a few traders who’s stake size is too large for the account they are trading. The important thing, especially when you are first starting out, is to make sure that you “Stay in the Game” as most of your learning will come when your actually trading.

The accepted level of risk amongst the professional traders and the trading authors is 1% of your capital on every trade. I used to trade with 2% risk, but that was far too much, and it still scares me today to think that I actually had that risk!! When your risk increases, any bad run that you have will be magnified beyond your control.


The chart I would like everyone to look at this week is BAY (British Airways) over a 6 month period on a daily chart. The advfn.com url is http://www.advfn.com/cmn/chrt/chrt_w...nd1_3=&ind2_3= and if you need help posting up a chart, then this thread should help you. http://www.trade2win.co.uk/boards/sh...&threadid=4624

As with the AAL chart, please draw in any support, resistance or trendlines that you think are relevant, and give a breakdown as before with,

An explanation of the trendlines drawn.
Trade : Buy now, Sell now, Buy at x price, Sell at x price or stay away
Risk profile with: Entry price, Target, Stop-loss and the Risk / Reward Ratio.

As always there is no wrong or right answers and I would love to see your analysis.

Take care,
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