If the definition of insanity is doing the same thing and expecting a different result, one has to wonder why so many forex traders (and traders in general) tend to repeat the same mistakes.
For the majority of traders, the “holy grail” is finding a method that will produce a high percentage of winning trades. While the cause may be noble, the facts are that no one really ever has. What traders should really be looking for is a way to make a profit with the least amount of winning trades. The secret to trading, if there is one, is really in what’s called the reward to risk ratio.
When I trade, the goal is to have at least a 2 to 1 reward to risk ratio, but what I’m really after is 3 to 1. With that, I can turn a profit winning just 33.3% of my trades, and I can break out even by winning just 1 in 4.
For example, my last trade was for a 180 gain against a 60 pip loss. Hitting just 1 out of 3 trades like this results in a gain of 60 pips and if I lose 3 and hit 1 (a 25% winning average), I break out even. Compare that to what many traders do when they trade with a negative reward to risk ratio. If you use a stop of 50 for a gain of 25, you’ll only break out even if you hit 66.6% winners and you’ll be a loser if you go .500. That’s a terrible way to trade because the reality is that it’s a guaranteed way to lose.
Setting up your trades this way is a bit more involved than just setting your stops and targets. You must adhere to one of my cardinal rules, which is that for a long trade, you cannot allow yourself to be stopped out where recent buyers have been and for a short trade, you cannot get stopped out where recent sellers were.
Likewise for setting a target-for a long trade, you must have fairly recent evidence that buyers have taken price to the level you’re targeting, and the opposite is true for a short trade.
These are the types of concepts I stress over and over in my trade room. The goal is to be profitable with the least winning percentage because during the times when you get on a role, the profits can really soar.
Double Dip For Europe
I believe that Europe is at risk for a double dip recession, and I base this on what happened in the U.S. during the Great Depression of the 1930’s.
After the government initiated its various fiscal policies and the Federal Reserve expanded the money supply, the economy bounced back strongly in ’35 and ’36. But the government was running a large deficit and President Roosevelt bowed to political pressure and cut back on spending. The government also raised taxes and the Fed cut back on the money supply. The economy then went back into a recession by 1937, and it didn’t come out of it until the U.S. entered W.W. II.
Well, the same thing is happening now in Ireland, Spain, Greece and Portugal, and it’s probably going to happen in Italy as well. These governments, by necessity, are reigning in their spending in order to bring down huge deficits. All kinds of taxes and fees are being increased, and it’s happening just as Europe is one the cusp of a fragile recovery. It seems obvious that since these countries are repeating the actions of the U.S. during the 1930’s, they’re destined to sink into a second recession that will be worse than the one that’s just occurred because this time around, they won’t be able to implement the same types of stimulus programs.
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