Friday, August 3, 2012

The hard road to consistency IV - Very few low risk trades

Your consistency will only improve when your outlook changes from looking eagerly to make a profit to watching cautiously to minimize risk. Letting trades go if they dont seem to match the risk to reward expectation is the basic underlying framework of any profitable trading system.

As long as you try to recognize every tradable patterns and act on them, you are likely to stay a breakeven trader or slightly better. Once you are comfortable letting trades go, you become a far better trader.

The larger your risk, the higher your chances of making a trade work, but also higher your loss if the setup were to fail. The bare minimum risk on ES is 5t.  If you are just starting out, your win rate is probably near 50%. At 50% a 1 point win such as the long above b11 versus a 5t loss actually works against you. To account for commissions and other costs, you need to take at least 6t just to breakeven.  You would really need to look for trades that give you 2x your risk.

On an average day, there may be about two to five low risk/high reward trades. Your goal should be to focus on them and not bother with the minor trades.

For example, today there were only three setups that gave 10t while respecting a 5t stop (marked with dots on chart). Technically, some other bars such as b60 and b20 may have worked but they were second entries or not clear setups.

The best risk to reward is the first deep pullback in a new move. b17L was the first deep pullback in a bull move and b69S was the first deep pullback in a bear move.

Measuring risk is also about knowing when you can trade and when you need to sit out. When bars are small (b23-60) you are usually better off sitting out until bars come back to normal. Otherwise, you risk the pattern play out just as you expected but unable to reach your target. Wait for decent sized bars and then look for setups.

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