GAME OF PROBABILITIES
At the end of the day, traders have two options: they can buy or they can sell, giving traders a 50/50 chance of actually being profitable. How can we increase our chance of being profitable?
One way is to trade with a very tight stop loss. The current sterling-dollar range is 90 pips given the Average True Range Indicator (ATR). This means that if we randomly open a position today and place a 90 pip stop loss, there is almost a 100 per cent chance that our position will still be open 24 hours later. If we place a 45 pip stop-loss order, then we have reduced the chance of the position still being open by 50 per cent. If we again reduce the stop loss, to 23 pips, then there is a 75 per cent likelihood that the trade will be stopped out 24 hours later.
Nonetheless, most new traders will insist on using a very tight stop loss when in fact they should, given their limited knowledge, work with a wider stop loss. So if you are constantly getting stopped out, make sure that you are aligning the odds to your favour. Check out the ATR indicator next time you place your stop.
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Alejandro Zambrano is a currency analyst at DailyFX.