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At 1:54 Al says "some traders want a high probability of success, and a good way to do that is to increase your risk, use a wider stop. Another way to do it is to increase your reward, for example go for a reward equal to 2x risk or more."
Why does increasing your reward increase your probability? Doesn't it lower your probability, since to get higher R:R you need to give up some probability to the other side?
Hey Garret,
Traders can use the Trader's equation to see how increasing the reward also increases the probability of success (profit) even on a lower probability trade.
The Trader's Equation, from Video 30A, Slide 11, ~16:38 is as follows:
(Probability of win) X (Reward) > (Probability of loss) X (Risk)
Here I plug in a 1:1 reward-risk scenario:
(60% probability) X (10 points) > (40% probability) X (10 points)
6 > 4
I say "reward-risk" because that is their order of appearance in the equation.
Here is the equation with an increased reward, and, as you mentioned, a decreased probability:
(40%) X (20 points) > (60%) X (10 points)
8 > 6
As you can see, even if traders take trades with a 40% probability, they can still be profitable.
Dr. Brooks reviews this concept and breaks down the numbers in the Video lessons. I'm not sure exactly where. He also talks about how to look for a DB/DT MTR, a setup that offers reasonable 40% probability trades that could also result in a 2x risk profit.
Thanks Ryan. But in your example you increased the reward and lowered the probability. I guess my confusion is coming from Al using the term "probability of success" which I don't think he clearly defines. I guess in this context he means the probability of having a profitable strategy over time, not just the probability of a specific trade working.
I agree. I'm pretty sure he is talking about success over time.
The math is pretty cool. Because, ironically, when you increase reward and decrease probability (while keeping risk the same) you can still get a favorable trader's equation.
There is a confusion in this somewhere: increasing the reward (target profit) will lower the probability of this trade being profitable. 😀
But, as you say, it can, longer-term, increase the trader's profits.
Hi,
at 1:36 Al is mentioning the probability of success so he is generalizing it to be a successful trader from my point of view this should make sense due to the mentioned context.
Hi Garret
Reward and probability go in the opposite way. If you have good probability, risk reward is not that good. And if you have a great risk reward, probability decreases.
What Al says, is that for nearly every trade, the worst probability is 40%, if you try to reach a 2:1m the traders equation is good: 0.4X2-0.6X1>0 and is as good as going for a 1:1 on a 60% trade.
Regards
Thanks Hubert, that's my interpretation. What still confuses me though is he says "SOME traders want a high probability of success." Wouldn't ALL traders want a high probability of success, which can be achieved through taking high or low probability trades as long as the Trader's Equation is good?
Apologize the late answer, what Al means is that high probability of success = high win rate so high risk = low reward in context to the traders equation. Obviously from my pov.
