If you have been using a proven strategy and you have been trading for a while, you will probably be reasonably sure that the results of your future transactions will be positive.
This is a good thing, as confidence is in itself very useful in business and in life. It stabilizes our emotions, our thoughts and out inner world, and puts us in the right frame of mind to make responsible decisions.
You can however never be one hundred percent confident, especially when you’re dealing with financial markets.
Probability and Confidence
We all agree that a military conflict may start at any time, a major bank may collapse overnight, or the UN might suddenly implement sanctions against a specific country. Any of these events can destroy all your carefully laid plans and lead to dire consequences.
In normal life, we often talk about the probability of an event happening when we try to predict whether it will happen or not. You will be making a big mistake if you don’t apply the same type of thinking when working in financial markets, as trading is nothing but predicting possibilities.
Two Is Always Better Than One
Let’s use the example of a trader using two technical indicators – RSI and Stochastic. Both of these indicators are oscillators and they are used to give the trader signals when the market is oversold or overbought.
The question is why the trader is using both indicators instead of only one. By using more than one indicator, the trader is simply trying to increase the probability of the transaction having a successful outcome, and he therefore waits for both algorithms to give a signal simultaneously. This is a good example of how you can work with probabilities.
Setting Criteria
This does however not mean you should take things to absurd levels by working with hundreds of analysis systems at the same time. There is a system of scoring transaction probability, which is mainly popular with American traders. This system will help you increase the probability of doing a successful transaction.
To do this, you’ll need to identify at least 2 to 3 criteria. Technical analysis professionals often use between 7 and 9 criteria to do the trading evaluation.
Calculating Scores
The value of analytical sources, indicators, candlestick patterns, formations, and the presence of a trend are all used as criteria. It is best to choose criteria from a number of different types of analysis.
Each criterion counts “against” or “for” a transaction. The more positive votes the transaction gets, the higher it scores. A higher score then translates to a higher probability of the transaction being successful.
Minimum Threshold
Let’s for example use 3 different indicators as criteria. One of the indicators gives a signal to go long, while the other two confirm this. The rating system therefore gives the transaction a score of 3 points, which is the maximum. This transaction should be carried out.
Traders however often don’t wait for the maximum score, but do the transaction when the score is lower. There is nothing wrong with this, but the trader should set a minimum threshold for themselves: they should for example get at least 3 points out of 5, or 2 out of 3 before opening a transaction.
Remember that statistics will determine the success of using this technique, and the minimum threshold can be adjusted based on your results.
Use probabilities as a tool and don’t rely on luck. You are the unique key in your trading system that will help you achieve success!