Let’s understand the term “Probability” first. What is probability? Probability is something which tells you the possibility of something happens which is 50-50% in the every aspect of the life. Similarly while trading in the financial markets, the trade has 50-50% possibility to end in losing side or winning side. That possibility is probability in trading. Even if you traded on high probability setup or low quality setup, your most trusted setup may fail and the setup who has low in rate may end the trade in the profits.
What Does Thinking in Probabilities Mean?
Probability thinking involves that any trade should not be impacted from the overcome of the last trade. Each trade should be defines as the independent event as the market are always uncertain. Probability thinking allows traders to accept the overcome of the trade. Whether it is a losing or the winning trade.
Accepting the Outcome
Rather than being the egoistic amid the winning trades or being the hopeless in losing streaks. Instead accept the outcome as the cost of doing the business. Because the market are unpredictable and anything can be happen in the markets.
Casino Method
Probabilistic mindset is similar to how a casino works. A individual may win 2-3 times in the casino but he/she can’t defeat the casino on scale 100-500 repeated events. Because has casino has proven edge which will make them win on the scale of 100 replicate events.
Win Ratio Vs Risk-Reward
Most traders or individuals mix these two terms win ratio and risk to reward. Meanwhile these two terms are totally different to each other. Win ratio includes the portion of successful outcomes relative to the failed ones. In simple words while testing the strategy in the live market, on a scale of 100 time how many times market reacted to that level. That’s is the win ratio.
Risk-Reward
It covers that how much you want to earn on the risk of 1. Like suppose that you took a trade now your sl is 20 pips and your target is 80 pips. So here the rr would be 1:4 because at the risk of 1 you want to earn 4x of what you are risking. Remember the risk would always 1 and rewards may vary sometime 2, 3, 4 and etc.
Win ratio and risk reward are two different terms one is based on the strategy and the other is based on the trade.
Necessary Risk Management
Probability mindset states that you should be ready to face every outcome by putting stop loss and target price in the trade. Here we will talk about the stop loss. Probability thinkers always works with the stop loss because they know the immortal nature of the market. By working with the stop loss they allow the probability to work in their favour next time if it didn’t work this time. Probability mindset protects your capital with the stop loss which allows you to survive in the long run.
By working with this logical path, will protect your psychology, improve discipline and keep you alive in the long run.
Why Many Traders Struggle With This Concept
Traders struggle with probabilistic mindset, approach, thinking because our mind isn’t designed for the work like trading and all. Whenever we risk money our human mind seeks assurance, confirmation, guarantee on the terms of profits outcome. Our human brain isn’t wired well when it comes to accepting the loss in the monetary terms. Our minds seeks certainty when it comes to the risking the money but this doesn’t happens when you are trading in the markets.
Understanding about the probability is essential for the strugglers traders. There are the some points or factors why it is difficult to understand.
Individual Trade Approach: Many traders judge their self worth or value from the single trade instead of the sequence. Any strategy who has 70-80% win rate in the market, may bring the 3-5 consecutive losses. When a traders starts taking the loses streaks personally and try to being the right all the time in the markets. That’s the they start engaging their emotions with their decision.
When Emotions Meet Risks: However the human mindset or brain can’t accept the pain of being wrong and losing. Meanwhile when a trader faces some losing streaks or a stop loss. They start connecting it to their self worth rather than taking it as cost of the business which leads to overtrading and revenge trading etc. The main struggle is when the trader has seen consecutive losing streaks, they are low in confidence they often cut their winning trade too early in the urge of grabbing the profit early. And continue the losing position in the hope of reversal.
Miscalculation The Math
Newcomers traders often look for the strategy who has win rate and sometimes they even aim for the 100% win rate strategy.
The Practicality: Pro traders works with the 50-60% win rate strategy in the market. Meanwhile they are profitable not because of win rate percentage but they focus on to capture the more pips when they are in the winning position. In sort their average losing trade is very smaller then average winning trade.
The Struggle: When a new trader predicts the price movement and the market start moving in the favored direction, this lead to the overconfidence. When the next time they trade and the market didn’t move as expected, they struggle to accept the pain of being wrong.
Every Trade Is Independent
The usual mistakes that traders does is they start judging their strategy based on single trade or outcome but in reality a single trade doesn’t define anything about you but the series of the trades does. Considering each trade is an independent event, the result of the last trade has zero impact on the present trade. This mindset will enhance and protect the psychology, discipline and reduce the emotions.
The Psychology of Independent Trades
Practical Ways to Develop a Probability-Based Mindset
Building the probability based mindset requires to accept the losses as the nature of the markets and treat the single trade as the single trade not like series of the trade. Meanwhile the focus is to remain consistent on a single strategy in the market, instead of focusing on the outcome.
Remove Aiming On the Single Trade: Try to execute trade fearlessly rather than thinking about the outcome then placing the trade.
Eliminate Emotions From The Trade: Take loss as the cost of the business, instead of personal validation.
Pre Market Analysis: Just a half an hour before the trading hours starts, always conduct the pre market analysis. Decide the daily bias, mark the setup. Plan the entry, exit price of the trade etc. After the trading hours conduct the post market analysis, write down the miss opportunity, mistakes or emotions.
Set Target Price & Stop Loss: Before placing the trade don’t forget to put the stop loss and target price. Because it will prevent your trading account from sudden spikes and movement.
Risk Small: Always risk the amount which you comfortable to lose. Continue trading with the small risk will ensure the survival in the long run of the trading.
Conclusion
Nobody can predict the price movement in the market. That’s why learning the game of probability becomes necessary. And it requires in the trading success.
Aiming and trading with probabilistic mindset and approach will preserve the trading account, improve the discipline, trading psychology etc. However it also improves the trading patience which eventually reduces the overtrading and revenge trading.
Success in trading doesn’t require being right every time. Success in trading comes from the consistency in following the same process everyday. Give yourself enough trades which allow the probability work in your favour.
Check out my previous blog on Uncertainty In Markets