http://www.financialstrategiestoday.com Hot topics in finance Sat, 15 May 2010 14:56:14 +0000 en hourly 1 http://wordpress.org/?v=3.3 http://www.financialstrategiestoday.com/the-use-of-average-profitability-per-trade-in-forex-trading/ http://www.financialstrategiestoday.com/the-use-of-average-profitability-per-trade-in-forex-trading/#comments Thu, 15 Apr 2010 20:21:34 +0000 GuestPoster http://www.financialstrategiestoday.com/?p=228 Click to read the article titled "The Use Of Average Profitability Per Trade In Forex Trading"

]]> When you trade with forex of other markets, the money managing strategy we are given is a pretty simple one: the average profit has to be higher than the average loss, all operations considered. This is a practice that everybody recommends, with obvious common sense in it, so must be a good thing. Nonetheless, if we take a closer look at the relationship between profit and loss, we will find out that this old rule should be revisited.
The relationship between profit and loss refers to the amount of average profits compared to the one of average losses, for each operation. For example, if you expect a 900$ profit and a 300$ loss from a given operation, the profit / loss ratio will be (900/300) 3:1.
Many books and many forex gurus teach that this ratio should be at least 2:1 or 3:1. This means that the for each 100$ loss you should have at least 200$ or 300$ profit. There is a lot of common sense in this rule: losses should always be as low as possible in order to maximize profits. Yet there are other factors that should be considered, like the everyday practice of forex trading, the individual style of trading, and ultimately the APPT: average profitability per trade.
The formula for APPT is as follows: (Probability of Win x Average Win) – (Probability of Loss x Average Loss).
For example:  Trader A has an average profit of 500$ and an average loss of 250$. The profit/loss ratio according to the traditional formula would be 2:1. If, on the other hand, Trader A has a long term win probability of 25% and a loss probability of 75%, the APPT will be (0.25 x 500$) – (0.75 x 250$) = -62.5$. As we can see, in this case APPT in this case is negative.
The last step will be to multiply the APPT with the number of trades I intend to do with a particular system, in order to have an accurate idea of how much profit or loss this system will accumulate in the long term.
Needless to say, a system that accumulated losses needs to be revised. If you are at the beginning of your forex trading career, the best thing would be to rely on a forex broker (ACM forex would be one of the most popular, but there are indeed hundreds of different providers around). With a forex broker, the profits will be lower, but the loss probability will also be limited, because the forex trading strategies will have been tested beforehand

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