The Importance of Approaching Forex Trading with a Probabilistic Mind Set

Approaching your Forex trading via the framework of probabilities is very important. Traders must realize that nothing is a ‘sure win’ in the Forex market and each trade setup has a chance, never a guarantee, of turning into a profit.

A trader who ignores this mind set runs into big trouble:

  • Overtrading and taking too many setups;
  • Over-risking on one setup, on your trading account or risk capital in total;
  • Being overly confident of a trade or strategy;
  • Not ready to handle losses or draw downs;
  • And there are probably many more: do you want to add some to this list?

Any of the above mistakes is very costly and ultimately could lead to an early exit out of your Forex trading business.

In fact, in response to Casey Stubb’s quest via twitter to gather trading tips and best advice from traders, I choose 2 things of the many available answers. One of them was never to expect a ‘jack pot’ or a ‘sure win’. See screenshot below.

30- 1- 2015 tweet

WHY THINKING IN PROBABILITIES REQUIRES TRAINING

To think in terms of probabilities requires training. The reason is simple: most people do not need to think in probabilities. I believe there are multiple reasons why thinking and approaching Forex in terms of probabilities is difficult for some/many traders but I will just mention 2 of them. However, please join the debate and add your ideas in the comments section down below.

  • When you travel to the office, drink a cup of coffee, or join a meeting at your job, then weighing the odds of success and risk versus rewards seems silly. Let’s be realistic, the odds of anything different occurring other than what’s expected are very small so it is not worth the mental effort.
  • Most people usually appreciate security and approaching trading in terms of probabilities could be in conflict with that.

BUT being certain of yourself, your environment, and your beliefs is not contradictory to seeing Forex trading in terms of probabilities. Let me use an example from Nate Silver’s book “the Signal and the Noise: Why so Many Predictions Fail – but Some Don’t”.

Nate wrote that a person who witnesses the sun set for the very first time is not certain whether the sun will rise the next day (remember this person never saw a run rise-just an example). Then the next day the person sees the run rise, and sun set again. This time around their assessment of the sun rising has increased a bit. When the sun rises the second day again, the observer increases the probability of this being a regular occurrence. Day after day pass and each time the observer adjusts their view that this is ‘normal’ until eventually the observer is 100% certain. (For those interested in more: adjusting our probabilities in face of new evidence is called the Bayes’ theorem.)

Many things in life are indeed as certain as a sun rise. Some things seem certain but in fact give a false sense of security. Other things are less certain and entering a trade or following a strategy is one of them.

To sum up: a trader needs to strike a balance. They must be (very) certain of themselves, their approach to trading, and their belief system, but on the other hand realize that trade setups and strategies are a probability and not a certainty.

Traders need to be confident on the one hand but accept the insecurity of the market on the other hand. The worst is when a trader is over-confident about the market (leads to over-risking, etc) or when a trader is under-confident of their approach and/or themselves (leads to missing trades, etc).

30- 1- 2015 audcad

HOW TO TRAIN YOURSELF

There is not one magic formula that provides an instant success. Most of the time, it boils down to a process where consistent efforts are required from traders. Traders need to train themselves to view strategy and setups as probabilities.

A trader who is trading a non-discretionary system is already highly exposed to probabilities. When making back tests traders quickly notice losses, losing streaks, draw downs, and slumps occurring regularly and can brace and prepare themselves for that. There is still an important difference between seeing a drawdown on paper and actually living through one as a trader.

A trader who is either beginning their trading business or is using a discretionary system might expect and/or want a high level of security (consistent success) from their trading endeavors. I mean that traders might anticipate/desire achieving an ultra high win percentage and they could be disappointed if the reality hits their radar. They fail to see the truth in trading: no setup is ever a guaranteed win and taking losses is a normal part of business.

The best training is practice, practice, practice. Here are the steps you can follow:

  1. Conduct back testing or forward demo testing;
  2. With each setup that meets your trading plan, estimate beforehand the probability success by judging a couple of factors (don’t make this list too exhaustive and long);
  3. Write down why in a journal;
  4. Monitor how the trade developed;
  5. Write down why you think that the trade did or did not work out as expected in your evaluation;
  6. Keep track how close your assessments beforehand are compared to the reality. So here you want to check when you give an 80% chance of a win, do indeed for 16 out of those 20 trades go for a win. You can keep track of groups of probabilities like 50-60%, 60-70%, etc;
  7. Make conclusions based on the assessments in point 6:
    1. If the actual win percentage is smaller compared to your assessments for one of the groups, then you are overrating the odds of success for a particular situation. Let’s say that the trades you assess with an 80% chance of success actually only win 65% of the time. You are over-confident in these cases.
    2. If the actual win percentage is larger compared to your assessments for one of the groups, then you are underrating the odds of success for a particular situation. Let’s say that the trades you assess with a 60% chance of success actually win 70% of the time. You are under confident in these cases.
  8. Attempt to understand why there are any differences in point 7.

Please add your opinion down below! We would love to hear your feedback.

Thanks for sharing and Happy Hunting!

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