quick snippet and very important and often neglected by most beginners in trading, is understanding the probabilities of winning and losing streaks .
lets take for example a trader who has a 5% edge on the market , which will render him having a success rate of 55% and failure rate of 45% .
it is a decent edge of a successful trader , and if his risk/reward is 1:1 ratio , he will end up wining on the long run .
but in a 1000 trades what is the probability of him having 6 losing trades in a raw ?
surprise to many , the answer is 100%.
more over he will have 60% chance of getting 8 losing trades in a row . and 17% chance of getting 10 losing trades in a row .
but why would we want to know that ?
the answer is , to prepare proper money management and avoid the risk of ruin .
lets say he starts with 100k USD investment, and risking 10% on each trade .
we know for a fact he will certainly get 6 losing trades in a row . its just math . we just don’t know when . it can be from day one trading or any other day in between . we are just sure it will happen.
assuming the streak starts from day one . 100k becomes 90k after first trade .
90k becomes 81k , after second .
then 72.9 then 65k then 58.5k then 52.61k .
so we are certain that he will lose almost 50% of his money at any given time if he is risking 10% on his trades. Which will make him obliged to make a 100% profit on whatever remaining investments he has just to break even to the point he started trading .
and to make matters worse he has 60% chance of losing 8 in a row which will leave him at 42.6 k .
and 17% chance of losing 10 in a row turning his 100k investment to mere 34.5k . almost 70% loss , that requires him to make almost 300% profit on that remaining money just to break even and go to the point he started !
this is an undisputed proof that not only trading skills are important to succeed in trading " and trust me 5% edge is hard to get " .
I hope this post was some how informative to anyone .