Risk and Probability

Concept of Probability
Concept of Probability

One of the most valuable measures of risk involves the concept of probability.

In trading, we can never be absolutely sure which direction the market will move, so we have to rely on probability to help us understand the odds of making a correct decision.

Probability can be expressed either as a decimal from 0.00 to 1.00, or as a percentage from 0 to 100%.

A probability of 1.00 or 100% means something will always occur, while a probability of 0.00 means it will never happen.

Keep in mind that when we analyze risk, we begin by looking at the probability of losing and not just the probability of winning.

Before making a trade, we should know exactly how much we are willing to risk.

Understanding risk allows us to make decisions that will help us develop safer and more profitable trading plans.

By testing a trading plan on i.e. historical data we can view performance reports that tell us the expectancy of the system.

The average trade net profit metric represents the expectancy of the system, or the average amount of money that was won or lost on each trade during the specified period.

It is calculated by dividing the total net profit (or loss) by the total number of trades.

This metric shows the average profit (or loss) the trader can expect on each trade to make over time.