A random walk risk assessment would be a trade that is 50/50. In this type of trade you have about the same odds of winning or losing. You risk 50 to make 50.
A high Probability trade would be something like 80/20. You are risking 80 to make 20. The probabilities of winning are much higher but the risk is also higher. You must maintain a high win rate to be successful trading this style.
A low probability/high reward trade is something like 20/80. You risk 20 to make 80. You don't win that often but when you do, it covers 4 losses.
---------------------------------------------------------------------------------------
Got that part? Good.
Now here is the interesting thing. What if you took an 80/20 trade where you risked 80 to make 20 but the probabilities were higher? What if that trade setup had a 90% win rate?
A 90% win rate means that 90 out of every 100 trades are winners. If you win 90 and lose 10, lets do the math...
90 winners x $20 per winner = $1800
10 losers x $80 per loser = $800
Total net profit = $1,000
-----------------------------------------------------------------------------------------------------------
So what happens when you find a really good deal. They are hard to find but if you look long enough, they will start showing up.
So lets take a trade I took today. I sold it for $34.50 and it has a 4% chance of expiring worthless. (If I am selling, I want it to expire worthless so I keep the premium paid for it.)
Now this is a rock -n- roll trade. It has a 96% chance of expiring a winner. If it loses, I lose more than the $34.50. I actually lose $65.50. Why would I not take this trade. Lets do the math below...
96 winning trades x $34.50 = $3,312
4 losing trades x $65.50 = $262
Net Profit = $3,050
----------------------------------------------------------------------------------------------------------
Now let us look at a real example. Let us take the EURUSD binary weekly spread this week.
According to the probability studies, there are probabilities for expiring above or below certain prices:
Probability of expiring, Friday at 3pm, above:
1.3575 - 1.21%
1.3525 - 10.37%
1.3475 - 39.67%
1.3425 - 77.05%
Probability of expiring, Friday at 3pm below:
1.3275 - 0.01%
1.3325 - 0.29%
1.3375 - 4.03%
1.3425 - 22.95%
1.3475 - 60.33%
As you can see, the probabilities match up pretty close with the actual nadex prices.
However there is a way to get around this. I will go into this further next time. I will give you a hint. It involves buying way out of the money binaries and selling shorter term out of the money binaries.
Don't have time today but hang in there...
Again, this little blog post was to just get you thinking a different way... HAPPY TRADING!