I sometimes take for granted that trading is a numbers thing, because it is obvious to me and I forget that others may not fully realize the importance of trusting probabilities and mastering the psychological states that are essential to good trading. I want to make it very clear how incredibly important this so that you better understand how to make money with trading. Very important post for all traders out there.
Suppose I tell you that we will flip a coin 100 times. Each tales you get 50$ and each heads you pay 25$. Would you accept to participate in this gamble? If no, then you are not a trader deep down: try a secure job and life, because you are overly risk averse. This gambling bet has an expected return of E(profit) = 100*(0.5*50 - 0.5*(25)) = 100*12.5 = 1250$.
ON AVERAGE, you profit 12.50$ per play (per trade). Does this mean you will win 12.50$ on EACH trade? No? Actually, maybe you will lose on 10 coin flips in a row and your confidence will be shaken... that will impact your perception of the world, but it will NOT change the expected profit of this game in the long run. As a guy who graduated in pure math, I tell you: nothing other than gravity is more certain than large-sample probabilities! This is strange at first glance, because there is a LOT of uncertainty on each coin flip... even on 10 coin flips! But as the number of coin flips increases, your EDGE will emerge and you will be a net winner. This is the very principle of casinos: the casino has an edge on the players and does not care about one specific time when it loses, as it trusts in the bomb-proof solidity of large-sample probability. There is a LOT to learn from this ridiculously simple example.
First, in this game, you have to PAY 25$ half of the time, on average. In trading, if you use too much leverage or risk too much per trade and you take just a few big hits that are totally NORMAL in terms of probabilities, you will not survive to benefit from the magic of large-number probability!
Second, you must deeply internalize and accept uncertainty: the result of ONE trade is NOT guaranteed, not even for the best trader in the world. This means you MUST pre-set some conditions that make you exit one specific losing trade so that you can "play" again and it also means that not every trade will stretch for 1000 pips into profit, so you gotta have some way of estimating where and why you should exit.
Third, there IS a compromise between the distance of your SL (stop loss) and TP (take profit target) distance from entry point and the probability of hitting them. If you set profit targets of 500 pips, you better accept that you will not hit them often AND you must leave more "breathing space" for price to move, because going for 500 pips might include lots of "up and down" wiggling and indecision" in the process, which means your SL will also be further away and your losses will be bigger.
Fourth, you CAN be profitable with almost ALL "win rates" - theoretically, you can win only 20% of the time and be profitable: 2*200 - 8*30 = +160... this is typical of macro trend traders: the win rate is low, but the wins are huge because they ride large trends. This type of strategy generally requires proportionally higher quality macro analysis. You can also be profitable with a high win rate and small wins: 7*40 - 3*30 = +190. Of course, the "ideal" setup is that you have a high win rate AND significantly larger winners than losers... this requires quality everything: chart analysis, understanding market momentum and mood, macro analysis, risk and money management, and THE thing that makes all this possible: emotional control and clarity of mind. You must find a system that you are capable of following and STICK TO IT long enough to see if it works - try it on a demo account. Believe it or not, this "system" that will give you an edge is NOT that hard to find. Yes, you read that right. I am not saying it is trivial or obvious - it does require research and effort on your part, but you will find an edge if you look hard enough - I promise. So why do most retail traders struggle so much to be profitable? One word...
You look at a chart. It has no feelings, it doesn't know you, and it doesn't care about you. The currency market is driven by a mix of fundamental forces (global capital flows due to all kinds of business and financial transactions) and the aggregate "belief" of the market participants, who are humans or computer programs designed by humans. The way you interpret this chart may be polluted by your wishing, avoidance/denial of reality, avoidance or pain, etc.
Moreover, ALL trading has TWO characteristics that must be deeply understood: 1) it is zero sum; 2) there is LOTS of money to be made. When you have such a mix, you naturally have predators (smart money) and prey (dumb money). Dumb money watches the chart and chases the market and is lead in one direction by smart money with all kinds of sophisticated psychological methods, then has its money taken away, etc. You know this, because you went through it...
In a zero sum game, if you do what everyone else is doing, you will lose. This is a mathematical fact. What does the majority of dumb money do? Set overly tight stops, not set stops, take too much leverage, chase the market, not "notice" obvious signs that he is on the wrong side of the market, not "see" a clear trade setup due to internal conflicts about making money, use magical formulas like "head and shoulders" and other magical thinking. Am I "against" this type of chart analysis? NO! I do it PLENTY and it DOES help an lot! But that does not give you an edge - everyone does it and it is quite easy... you need to have deeper understanding of the market and not fall victim to the psychological traps of denial, avoidance, cognitive capture / information bias, fear, greed, and all the other mental toxins that make you see reality with a distorted lens due to your inability to "see" and "notice". This seems complicated, but it is not... LOOK AT THE CHART without "wanting" to seen buy or sell pressure or anything else - look at it as it is! Just "notice" what IS. Were recent up candles very convincing? Is this the bigger picture or are you seeing something much bigger than it really is (e.g. looking at a 5 minute chart and telling yourself that "price can't go any higher", while you are at a 5-year historic low).
On any currency pair, smart money NEEDS buyers and sellers to make its planned transactions. Suppose a large hedge fund or bank has a huge holding of AUD that it wants to sell. This will be done in highly elaborate ways. It will sell its AUD load in several "chunks" and it will hide what it is doing as much as possible. Why?
You need to 1) understand and TRUST probabilities and large number sampling; 2) KEEP LOSSES SMALL relative to profits, but understand that setting overly tight stops only increases the probability of hitting them; 3) find a system with a small edge that works for you and your personality, which can have an 80% win rate or a 20% win rate; 4) look at the market without emotions and see what IS without distortion, and for this to be possible, you have to... 5) work on mastering your emotions, ego, psychology, focus capacity, stress management, and so on, and finally... 6) enjoy the process and never stop learning! Never ever stop learning, reading, working on yourself and your strategies and your understanding of the market.