Mathematics of stock trading

Mathematics of stock trading

Posted: Tory Brunet Date: 09.07.2017

By Deron Wagner trading education articles 10 Comments. What percentage of the time do you think a trader needs to have winning trades in order to be consistently profitable over the long-term? Read on to learn why…. On the contrary, such a high percentage of winning trades is not at all necessary in order to rake in trading profits year after year. But wait, you say.

The Mathematics of Getting Rich by Investing in Stocks

How can a trader or investor who is only netting a gain on 4, 5, or 6 out of every 10 trades still come out a consistent winner in the end? It makes sense, right? When I eventually realized that consistently profitable trading is merely a numbers game that requires a slight mathematical edge much like card counting in blackjack , it was fantastic news for me!

How to Use Math to Gain Success in Stock Trading | Finance - Zacks

It meant that I did not have to be a superstar stock picker, or even a really good one, in order to be a stock market winner. Rather, I only needed to develop a trading system that ensured my average winning trades were significantly larger than my average losing trades.

However, the dollar amount of my average winning trade to average losing trade has been roughly 2 to 1. The great news is that making sure your winning trades are larger than your losing trades is easier than one might assume. Ensuring the necessary mathematical edge for consistently profitable trading only requires the discipline to do three things consistently. When you are holding a trade that is steadily moving in your favor, it is absolutely imperative to let those profits ride as long as the stock or ETF maintains that trend!

In healthy markets, leadership stocks usually small to mid-cap stocks with strong earnings growth and high relative strength are driven by the huge momentum and demand of institutional buying. After a stock breaks out of a valid base of consolidation and enters into a steady trend, that trend typically remains intact for many months, or even years. Furthermore, the longer a trend has been in place, the more likely that trend is to continue.

On the contrary, you should be pleased every time a stock falls to your stop price and you exit the trade with a loss. Because it means you are maintaining the required discipline to become a consistently successful trader over the long-term. Have you ever stayed in a bad romantic relationship too long, rather than simply cutting your losses and moving on? I have, and in hindsight I can assure you that nothing good ever comes out of such a situation. The same is true in trading. You now understand the importance of letting momentum work in your favor with winning trades, and the need for getting out quickly when the situation reverses, but the glue holding these two elements together is knowing where to set your initial stop loss price when entering a trade.

Not surprisingly, there are a plethora of technical indicators to assist traders in knowing precisely where to set stop losses. One method is to set a stop loss just below technical support of a popular moving average the 20 and day moving averages work well for short to intermediate-term swing trading. Nevertheless, I could write an entire chapter of a book dedicated to knowing where to set your stop loss prices I already have. For most ETFs, on the other hand, I use tighter stops because many but not all of them have lower volatility.

I only need to make sure that the percentage gain of my winning trades is expected to be at least twice the percentage loss of my losing trades. This is known as a reward-risk ratio, and the minimum ratio I always aim to achieve is 2 to 1. This means my expected potential reward the amount I will gain on the trade if it hits the area of my target should be at least double my risk the amount I will lose if the trade hits my goes the wrong way and hits my stop.

Trying to count the number of mistakes I made when I was a new trader would surely give me a headache. Even now, occasional mistakes are unavoidable. If this article inspired you or gave you some good for thought, please share with your favorite social network by clicking icon on the left and drop us a comment below.

Sign up for your day risk-free subscription today. Hard work and dedication to scan for the best stocks to buy cannot be avoided. Just found your site. You know what I like about you? How damn simple you make it. I guess it doesnt have to be complicated with hundreds of indicators.

As a newbie, I find your blog refreshing and it relates to my personality as a way I think I want to trade. It seems all of the good traders have one thing in common. They cut their losses short. Thank you for sharing your expertise and insight. Really happy that you are discovering the beauty of simplicity in trading. It certainly reduces the stress levels, which ultimately prevents burnout. I have one question: Should the stop loss amount be same in all the trades?

Hi, sorry for the late response. It is best to keep the dollar loss constant when trading the same type of setup. For example, our best setups occur when a stock is breaking out from a strong base.

We like to put size on before the base breakout and add the rest at the breakout.

However, say in two weeks, the same stock offers a pullback entry off support at the day MA, then we might only risk. I hope this helps, if you have any other questions please let me know. Also, If you are new to trading and do not know which setups carry more risk than others, I would suggest trading all setups with the same percent risk of account equity. Thank you again, I hope this helps. Notify me of follow-up comments by email.

Trading Blog Strategy Newsletter Archives Performance Stock Screener Contact Us. Check out these related articles: You have to research a lot into the stock trading to do well: Hi Todd, Thanks for the kind words.

That is a great post and explained in a very simple way.

mathematics of stock trading

So, this would disturb the risk reward ratio. How should this be handled? Thanks, glad you liked it. Leave your comment below!

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