Forex’s Traders always heard that trading probabilities is one of the most effective strategy that will guarantee sustainable profits and the best way to minimize lost. But many of them don’t know how to do so. This article will explain trading probabilities from engineering background in order to sustain profit and minimize lost, and most of all to make traders accept any lost and never get greedy when won because it will make trader realize that FOREX market are just a simple random movement that no one can guarantee where is the market is heading.
First of all let us prove that the market is a random movement of price where traders try to predicate its next move in systematic way but 90% failed. Many traders use indicators such as moving average, MACD, RSI and stochastic in order to decided either to buy or sell. And many traders who buy or sell based in those indicators lost there trades. why is that?
The answer is very simple and straight forward, because the market is not moving in systematic way. Because if it was, then when you buy based in these indicators you should win as well as when you sell, but since the market is moving in random way you keep losing even when you used these indicators which suppose to help you to win not losing.
Since market moving randomly, the only way to understand it is by applying possibilities or outcomes for its next move and assigned probabilities for those outcomes and see which possibility is more likely to happen next.
When traders treat market as random experiment they will understand it clearly. Any random experiment has an outcome and each outcome has probability of occurrence. If you deal with Forex market as random experiment the outcomes lie in three possibility (up, down, or sideways). Each one of theses outcomes will be assigned probability as following:
|Market’s next Move||probabilities|
Once siting the outcomes and their probability, traders have to build a hypothesis for each outcome and either accept or reject that hypothesis ( hypothesis mean that assuming the market will move up and then test that assumption with evidence and see if this assumption is still valid or not).
The first hypothesis is market will go up. To test this hypothesis in order to accept or reject it you can ask the following question :
- Is the market making higher high and higher lows, if yes that mean the market is in uptrend, and this hypothesis is still accepted.
- Does the market pullback to a support and retrace to its original direction which is up with strong candlestick reversal pattern, if the answer is yes then this hypothesis is still valid.
- Keep going in asking questions to end up with either accepting this hypothesis or reject it.
- Then you divided the probability for this hypothesis which is (33.3%) by the number of the questions to get probability for each question.
- In the above example we had two questions and the probability for each question will be (33.3/2) = 16.65%.
- Then let us assume that the answer for question one is (yes) it is an uptrend, and the answer for question two is (no) the retrace was not strong.
- That means we had (+16.65%) and (-16.65%) because the second question’s answer was no.
- That mean the remaining probability for this hypothesis which is uptrend is (33.3%-16.65%)= 16.65%.
- Now we have a probability for our first hypothesis which is one of the outcome that market is heading up equal to = 16.65%. Sometimes when all answers are not satisfied that mean we reject this hypothesis and the probability for this outcome equal =0.
- Now we can be certain with a probability of 16.65% that market is moving up. But the remaining percent which was substructure earlier can be added to either the down move hypothesis or sideways in order to end up with higher outcome from three which are (up,down or sideways) and see which one has the higher probability and trade it.
- Now you can repeat the process form (1 to 10) to end up with the probabilities for down movement and sideways.
- Once you preform these processes and come up with all the probability for all three outcomes then you can trade in direction of the outcome that has higher probability using price actions or any other secondary indicators such as (Moving average,MACD,RSI).
Randoms experiment can be varied from tossing a coin to see the outcome if it was head or tail, to more sophisticated experiment such as predicting the Market movement. In my opinion Forex market is a random experiment where a lot of factors contribute to its movement that hidden from the ordinary trader. For traders to understand this market I urge her to go back and study the random experiment in details to come up with a strategy – or update the above explained one – that help her beat the market by making profit consistently and accept lost. I know that will never be hard for Forex traders because they were able to make profit with this giant market but were not able to keep it because they never think about the market as it is moving randomly.