Trade with an Edge

Probability Trading - Thinking Differently

Probability trading requires a different way of thinking.

When I first started trading, I didn't get it. I was so wrapped in the technicalities of trading, the concept of thinking in terms of probabilities passed me by. I guess it must be the same for a lot of people judging by the questions I get and observe in the various chat forums and webinars.

Not thinking in terms of probability trading means your entire focus is on the individual trade. Each one must be a winner. It's important to not be wrong. Expectations and hopes for that trade build up. Frustration sets in when those expectations are not met. A single loss effects you emotionally. A string of losses can be the cause of considerable psychological upset - effecting your judgment on subsequent trades.

On the other hand, probability trading requires less stress and less emotion. You're focussed on the longer term - the outcome of a larger number of trades. An individual trade is not that important in the grand scheme of things. A string of losses doesn't faze you. Because you're confident the odds are on your side.

Probability trading means buying into 2 key principles:

1. Individual Trades Are Not Predictable

Individual trades are totally unpredictable.

It is impossible to predict if a trade will be a winner or a loser.
It is equally impossible to predict how much profit a particular trade may make.

2. You can predict the outcome of a series of trades - when you have an edge

If you have a consistent trading method - (e.g. harmonics) - that gives you an edge over other traders at certain times, - i.e. when probability is on your side - then you can predict the overall outcome of a series of trades.

These two ideas sound at first as if they contradict each other. But they don't.

Spin an unbiased coin 1000 times. The probability of heads is 50%. But you can never know before-hand how each spin will work out - heads or tails. However, you know over 1000 spins that you'll get a heads approximately 500 times.

Now imagine your coin has a small 1% bias towards heads, so the probability of getting a heads is now 51%. You now have an edge. And after 1000 spins, you can expect to get about 510 heads.

Mark Douglas, in his book "Trading in the Zone", describes probability trading very well, with some very good exercises designed to teach you how to think in probabilities.

So how do you make the probabilities work for you?

Trade Whenever You Have An Edge

What it all means is this. If you have a trading method - like harmonics - that gives you a trading edge, then at those times when probability is on your side and your rules on risk (leverage, risk/reward ratio) checkout ok, then you must take the trade.

You have to keep "playing" in order for the probabilities to work for you. But in any case, why would you not want to?

Other pages in this series on Harmonics Basics are: