The 2 most important fundamental characteristics of trading that every trader should know
Investors typically invest in a stock market and for the most part do well. Since a stock market, if properly diversified, has a natural upward bias. The only limiting factor is time. Like property if you hold it long enough long-term investing should give a positive return. Because we have decided to be active traders, we work in the realm of probability instead of biases. This means we must have an edge in our trading system that gives us more of a chance of winning.
I have many of my students say that the market can only move up or down, a 50% chance, but they forget, where are the stop and target? This would only be true is we have a risk reward at 1:1, i.e. the target is the same distance as the stop loss. Nevertheless, we would lose on spread, slippage etc on every trade and only then we would be losing instead of breaking even, theoretically. But we are here to make money, right? To have an edge that is positive we therefore need a high win loss ratio, if we have a 1:1 risk/reward ratio or a high risk/reward if our win loss is under 50%.
Professional traders look to have very high risk/reward ratios and a win/loss of about 40%. This will give a strong edge. And, there are two mechanisms to achieve this. They a synchronous meaning one must happen for the other to work.
The first is Market Timing – where to enter a trade so that we can reduce our risk quickly and enable an excellent risk reward ratio. This can be broken down further to Evidence based plan – Allow the market to commit to you first before you take an entry. This, however, reduces you risk reward potential but increases win loss ratio. And, Antagonistic based plan – Assume the market is going to react at a certain point to reduce risk to increase the reward however the win loss ratio will increase.
The second one is good Risk Management. What are the steps to take to reduce risk? How much of you trading float to risk per trade? What point do I move my stop? These plus many more are questions to manage your risk and keep consistency in your trading.
These concepts take more than just this article to comprehend and I understand you maybe left with more questions than answers. You can learn the full story in the ConvergenceTrader.com course