Pimp My Trade

A Strategy for Consistent Profits

Posted on March 5, 2009 by Adam

Trading is hard - I’ll be the first to admit it. But that doesn’t mean we can’t be profitable over time, even if the market is down.

The key lies in defining your risk and reward on every single trade

What do I mean by risk and reward? I define risk as the maximum amount the trade can move against me before I exit. That’s the price where I place my stop-loss. I define my reward as my target price when compared to my entry price. It is essentially my estimation for how far the trade will move in my favor.

So who cares - I’ll be you could do that in your sleep!

The fact is, if you can accomplish the task of defining risk and reward, you have what it takes to be profitable in trading.

Let me give you an example. Take a stock that’s trading at 50. Say we enter a bullish position with a price target of 52, a mere 1% move, and a stop-loss at 49. If we enter when the stock is trading at 50, that makes our reward $2 and our risk $1.

If we were to take that trade 100 times, and the stock achieved our price objective 50% of the time and reached our stop-loss the other 50%, then we will have made a profit of $50 on each share we traded. That’s not bad considering we were only right half the time!

The key is finding the lowest risk setups.

In general, in order to break even trading, the probability of your trade succeeding must be at least equal to Risk/(Risk + Reward).

In the above example, we would need to be right only 1/3 of the time to break even, since 1/(1 + 2) = 1/3.

Even a beginner chart technician can identify setups that will be fulfilled 33% of the time. Some research suggests that price patterns, once confirmed, will reach their price objectives over 60% of the time!

The bottom line is, find setups that offer low risk to reward ratios. You account balance will reflect your decisions.