In the wonderful world of trading (and
any business for that matter), profits are king. If you're not taking
in consistent profits, then you're not doing your job as a trader.
It's a simple business model, but it lies at the heart of every
successful enterprise; Keep profits up by placing trades that give
you a high probability of success. The only problem is; how do you
know the trades your taking have a high probability of winning? Well,
that's why I'm here. I'm going to give you some easy to follow
guidelines that will help you achieve that goal.
Before I delve in. I want to pose a few
questions that you should be thinking about as you read on: What do
you define as high probability? How do you spot, and place trades
with a high probability of success? How do you define consistent
profits?
Okay, lets begin.
1. Recognize that limited profit
trades have a higher probability of success than unlimited profit
trades.
As a trader just
getting started out, I learned about the difference between limited
profit trades, and unlimited profit trades. When thinking about these
types of trades, it is important to distinguish that we are speaking
in regards to profit potential, and not what could actually happen. I
mean really think about it, there is no trade where you will have an
unlimited upside, and leave on forever. It's all about the potential
though, and that's what threw me for a loop when I first started
trading options. I figured that limiting my potential profit was
probably the stupidest thing I could do, and wanted to only learn the
trades that gave me an unlimited upside in terms of profit potential.
The problem with
this thinking is that the trades that offer the tasty unlimited
potential temptation, carry the most amount of risk. High risk equals
high reward right? Well that may be very attractive in theory, but
every successful trader out there knows that in order to make it,
they must limit their risk as much as possible while still
maintaining a decent profit curve. Doing so allows the trader to stay
in the game, and increase their odds by giving themselves enough
chances for the numbers to play out (see # 2). Remember, high risk
may equal high reward, but it also lowers your probability of success
by putting your capital at risk. The longer you can keep making
trades, the better your odds of success will be.
All trades that
limit your profit potential also limit your risk, which naturally
places you in a position to increase the odds in your favor. So in
essence, these trades do your job pretty much for you. You just have
to know when to place them, and how to manage them once they become
profitable. If you stick to proper risk management rules (read Howto Manage Risk) then you'll only ever have to worry about
managing your winners, and you'll be able to stop stressing over your
losing trades, and thus increase your probability of success.
2. Know the percentage chance that
your trade will be profitable.
Now this may seem
like it's voodoo to those who don't know how to do it, but every
option chain offers this information in some form or another. In the
ToS platform, they provide metrics that will show you probability
OTM, probability ITM, and probability of touching. These come in very
handy. It's as easy as changing the settings of the option chain, and
they become visible for every option you look at. If you don't have
these metrics available through your broker/platform, then you can
always gauge the probabilities by the Delta. You just have to look at
Delta as a percentage scale, and your golden. For example, if an
option you're considering is Delta .30, then that option roughly has
a 30% chance of expiring ITM, or 70% of expiring OTM.
Imagine how much
your trading will change when you can look at that OTM option you're
thinking about buying, and realize that the probability of it staying
OTM is 80% in the current market environment. Yea, that option may be
cheap, but it's cheap for a reason, and suckers like you have been
taking that bait for years in hopes that your cheap investment will
turn into a big winner; when the reality is that there is only a 20%
chance that it will become profitable. Ouch. Want the bleeding to
stop? Then stop placing trades based on price, and start placing them
based on the probabilities that they will become profitable. Place
enough of these trades, and over time your equity curve will thank
you.
3. Focus on managing your winners,
not your losers.
This was mentioned
a little earlier, and it's a concept that is taught in very few
places, but it's catching on because it actually works. The general
knowledge base would have you focus on managing the losing trades
with very little emphasis on what to do with winning ones. Well that
way of thinking is outdated, and frankly does not work. As I stated
earlier, if you're following proper risk management rules, then you
never have to worry about your losers (provided you're also following
#2), and you can shift your focus onto what it should be doing in the
first place; profit taking. After all, you do want to be in the
business of making profits right?
So how do we
manage our winners? The answer is simple. Take your profits when you
have 25 to 50 percent of your max profit potential. Yes, you read
that right. Don't get greedy, and don't risk taking your trade to
expiration. There are too many variables at play, and every trade
stands to be a winner, and a loser at some point in time. So if
you're making high probability trades (anything above 65%), and
taking your profits when you have them, you'll be increasing your
probability of success dramatically.
There you have it.
3 Unique ways to increase your trading success, by focusing on
probability of profit. I know these ideas work from first hand
experience, and if I can profit from them, then so can you. If you
have anything to add, or have any questions you would like to ask,
feel free to leave something in the comment section below.