October 15, 2024
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Read time:
4 Minutes
Why does it feel like the market’s against you, and every time you open a trade, you lose?
There’s probably a good reason, and it might not be what you think. I can tell you, it’s not just bad luck or that the Market Gods are against you.
Whenever I see people saying things like, “The trade didn’t go to plan”, or “Every trade I open is a loss”, when I dig a bit deeper, it’s usually the same situation.
Most traders structure their trades with favourable risk-reward ratios. It’s what everyone’s told to do, and in many cases, it makes logical sense for the opportunity. It’s also likely causing you problems.
Firstly, what do I mean by asymmetric risk-reward?
It’s really simple: one side of the potential outcomes is larger than the other. For example, if the bullish outcome is 80 pips and the bearish outcome is 20 pips, and you’re going to be entering a long trade, it’s a 1:4 risk-reward ratio. For every 1 you risk, you have the potential to earn 4.
This isn’t inherently a problem—in fact, most of my trades are asymmetric too.
The real issue here is perception.
Imagine you take the trade from the previous example (80 pips against 20 pips), but you have absolutely no edge in the market. Out of every 100 trades, you’d expect to lose 80 times and profit 20 times. In other words, without any edge, the probabilities are 80% for a 20 pip loss and 20% for a 20 pip profit.
Instead, let’s say you do have an edge, which is why you’re taking the trade in the first place.
It would take a monumental edge to shift the probabilities enough to make a profit more likely than a loss. It’s unrealistic; the difference in outcomes is just too great.
That means, even if you have an edge, most asymmetric trades are still more likely to result in a loss than a profit.
Having an edge doesn’t mean your trades will result in more profits than losses. It means the probability of a profit is better than random, so your trades have a positive expectancy.
For example, rather than a 20% probability of an 80 pip profit, you might be trading the opportunity because you estimate it has a 25% probability. Each individual time you take that trade, it’s more likely to be a loss, but if you take that trade 100 times you’re expecting to lose 20 pips 75 times and earn 80 pips 25 times, leaving you with an overall profit.
Therefore, just like any other asymmetric trade, it’s a false statement to say, “the trade didn’t go to plan” if it loses. The result was in line with probabilities; what didn’t go to plan were your expectations.
Likewise, a losing streak is completely expected if the chance of an individual loss is over 50%.
The problem is, most traders don’t embrace this and they allow it to negatively affect their decision making. After a string of losses, they begin doubting their trading approach. Instead of seeing it as statistically normal, they start finding what they need to change and improve.
This begins a negative spiral of self-sabotage. They tweak their system and over-adjust; only to see inconsistent results again. So they tweak some more, adjust again, and on and on it goes, until they end up gripped by confusion and inconsistent performance.
Rather than having a temporary drawdown that eventually becomes profitable thanks to their positive expectancy trades, they secure themselves a permanent financial loss by accidentally engineering a negative Trader’s Equation.
I also see this happen when traders analyse their data. They’ll look at their trades over the past couple of months and notice their success rate is lower than it needs to be for them to be profitable. For example, let’s say a trader only takes trades with a 1-to-4 risk-reward ratio, and they anticipate achieving a 25% success rate. But their data is showing they’ve only been hitting around 20%.
Alarm bells start ringing! They’re certain something is wrong and begin investigating the problem.
In those moments, it’s important to reconnect with reality. If you’re expecting 25% of your trades to be profitable, that would be 10 trades out of the 40. On the other hand, 20% is just 8 out of 40 trades—a difference of only two trades!
Within a small sample size of 40 trades, that sort of variability is to be expected. If you want to succeed at trading, you have to understand the basics of probabilities and statistics.
Let me be blunt…
If you’re losing overall with your trading, the chances are very high that it’s because your approach is useless.
But, before you come to that conclusion, you have to give your approach the chance to perform. You have to collect a large enough sample size to draw meaningful conclusions.
The recommended sample size for appropriate conclusions with a high confidence level is 385.
With all trading, but especially with asymmetric risk-reward, you have to allow the expectancy of the trades to play out over time. Assuming your trading system is useless based on a handful of trades is like deciding you’ve got minutes to live just because you coughed.
Having the right perspective is key.
