Pimp My Trade

Trading Strategy: Low Risk, High Probability

Posted on February 5, 2009 by Adam

It’s easy to find setups once you know what you’re doing. I firmly believe that technical analysis is a skill that can be practiced and learned. Along the way, most traders come to find that being able to understand and practice technical analysis is not enough to beat the markets.

Sure, I can identify price patterns all day long, but it won’t necessarily make me profitable. Trading is about so much more. It’s an amalgam of psychology, discipline, and judgement. Among those, technical analysis is only one piece of the puzzle.

When I size up a potential trade - one that I have identified as a candidate using technical analysis - the first thing that comes into mind is:

How much can I lose?

Huh? WTF?

“C’mon Adam, let’s talk about how much money we’re going to make!”

That’s the wrong answer, I promise. So much of trading is about managing your risk! That should be repeated. So much of trading is about managing your risk! If I focus on how much it will cost me if I am wrong, that is, where do I place my stop, then I can always keep my losses small. If you can do that, then your winners will take care of themselves. With my trading style, I can afford to be wrong about 50% of the time. And I’m not ashamed to admit that sometimes that is the case, because even when it is, I’m still making money.

If you aren’t using a stop loss, you should. Even if it’s a mental stop loss. Sometimes I will set a mental stop, contingent on a close beneath (or above) a certain price level. That usually works for me. The trick is to find setups where you can set your stop very close to your entry point. That way, if the trade goes against you, it costs you very little to find out you were wrong.

The other factor I consider when sizing up a trade is probabilty. I try and find high probability setups. How do I do that? First of all, I don’t try and trade against the trend. If I’m looking to get long during a bear market, I screen for stocks that are displaying a nice uptrend, or at least are outperforming the market. The other nice method I sometimes utilize is using point and figure charts. Look for stocks trading near their trendlines. Usually the first test of a trendline results in a reversal. Finally, setups become more probable when you’re looking at a new relative high or low. When a stock is making a new 52 week high, I might want to consider it on a pullback, as it is likely to go higher.

Keep these factors in mind when you’re sizing up your trades:

1. Low risk
2. High probability

In the future, I will be posting some more specific trading strategies that I use. In particular, I’ll show you a chart setup I find all the time, which I have been very profitable with.

Cheers