Probability in case of a trading system

Probability is of great importance to forex trading, but the influence of probability is often underestimated in actual practice. A consequence of this is that people cause unnecessary problems for themselves or they are going to start building on a wrong foundation. In this article I’m going to show the influence of probability when it’s about a forex trading system and the risk/reward ratio of a forex trading system.

In the article “Online forex trading is simple” I already indicated that a lot of beginners are making a mistake by hastily going to look for a forex trading system, resulting in the foundation of this system being inadequate caused by this unnecessary haste. This has mainly to do with the fact that they fail to understand the influence of probability sufficiently and that they consequently also fail to create the right mindset to become successful in the long term. In this article I’ll consider the influence of probability more thoroughly when it’s about a forex trading system as well as the risk/reward ratio of this forex trading system.

Forex Trading System

Let’s take it for granted for the sake of convenience, that each time you’re going to risk $20 to be able to gain $20. This means that your risk is equal to the possible yield. When are you going to start making profits? Quite simple: If you conclude more positions in a profitable way instead of in a loss-making way, that is to say, if your success rate exceeds 50%. The exact success rate isn’t important right now, because that goes only about the extent of your profit and in the framework of this discussion that’s not relevant for the time being.

To put it briefly: You want to create a situation in which you only open positions, at which the expected success rate has to surpass 50%, that is to say when the odds are at your advantage.

Risk/Reward ratio

In the above mentioned example you risk each time $20 to be able to gain $20. The relation between the amount you’re risking and the possible yield is occasionally called risk/reward ratio in the case of forex trading.

Risk/reward ratio = relation between the amount you risk and the possible yield.

In the example came up that we had to reach a success rate of at least amounting to more than 50% to be able to profit in the long term. De risk/reward ratio in that case amounted to 20:20=1, that is to say that the risk is equal to the possible yield.

However if we apply another risk/reward ratio, the required success rate will also change to be able to be profitable in the long term.

Suppose each time you’re risking $20, but this time your possible yield may amount to $40 instead of $20. De risk/reward ratio in this situation amounts to 40:20=2, that is to say the yield is twice as big compared to the risk. Which kind of success rate do you have to reach at least in order to be profitable in the long term?

As the yield is now twice as big when you conclude a position profitable, you’ll already gain a break-even result when you profitably conclude 1 out of 3 trades, which means a success rate with the size of 33,33%. To be able to make a profit, you’ll have to gain a success rate exceeding 34%.

By means of the below shown chart, you’ll very easily get a clear view concerning the necessary succeeding percentages to get a break-even result in case of various risk/reward ratio’s.

risk-reward-ratio

As you can see the risk/reward ratio of a trade setup has a great influence on the required success rate to become profitable in the long term.

Making profit should be your first priority!

Especially when you’re just about to start practicing forex trading, your first priority should be consequently gain profit with your forex trading system. You can reach this goal by taking care of the odds being in your advantage!

This principle is quite simple, but it is of the utmost importance that you keep this in mind thoroughly.

It’s obvious that you strive for making as much profit as possible, but in that case we’re talking about fine-tuning the forex trading system en we’re still going to discuss that matter a bit later on.

As a result of this article, you’re by now aware of the fact that, with the help of a simple calculation of probability, your main purpose should be to gain profit. If we leave the psychological mindset and a good risk management out of consideration for a while and have a sheer look at the probability in case of a trading system and at the influence of different risk/reward ratio’s, you can already get a view of a possible objective by means of a simple calculation.

In the next article I’ll show you how to put this theory into practice based on the OFS Trading System. Then the influence of probability will also be discussed when it’s about the right mindset for forex trading as well as the influence of probability when it’s about handling a proper risk management.

Summary of the article series “Forex Trading is simple!”:

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