Good discussion everyone! Good points @Mod-MattZ, in some ways we mean the same thing, but I’ll try to clarify my perspectives:
Risk and reward are things that we have control over based on where the target and stop are set. However, probability is an important variable that has to be taken into account, even though we can never know it with certainty; it is based on market tendencies. You’re making an assumption that the probability “at ANY point is 50/50” however this is arguably incorrect (I’ll expand on this below). It is more accurate to say that the outcome of an individual trade cannot be known ahead of time, but that is not the same as saying that there’s a 50/50 probability at any given moment. If that were true, then why bother looking at charts, order flow, Profile, or anything else? Trade location matters because it is tied to probability. I’d argue that a lack of exactness, in the way that risk/reward can be exactly assigned, does not make it less objective. An assessment of probability doesn’t necessarily rely on intuition or subjectivity (though we are always trading our beliefs of the market in some way or another so I don’t think there’s a reason to dislike those softer attributes). There are objective and subjective aspects to any trade that is taken.
We’re actually talking about the same exact thing, we’re just using different words to describe it. This equation, if rearranged is the same as the trader’s equation that I talked about in a prior post. The terms “probability” and “win rate” are interchangeable. The key thing to note is that this equation takes risk, reward, and probability into account. All three variables are important.
I want to expand on the idea that “at ANY point it’s 50/50” because I think that is at the heart of where we disagree (we both agree on the use of the expectancy formula which Brooks calls the trader’s equation). I think you’re using 50/50 to describe the fact that we can’t know whether or not the current trade will be profitable. It is true that we can’t know the outcome of a trade ahead of time, but that does not make the trade itself a 50/50 proposition. The approximation of probability is based on the likelihood of one thing happening over another and in many instances that is not 50/50. Probability, as I view it, is approximately assigned based on the behavioral tendencies of the market. If a certain behavior tends to play out in a particular manner, for instance, 70% of the time, just because this current trade may result in a win or a loss does not mean that the trade itself has a 50% probability or that somehow a series of 50/50 trades becomes a behavioral pattern that holds in 70% of cases. “Win” or “lose” are two different potential outcomes, but they don’t necessarily have equal probabilities. To put it another way, I’ll use an extreme example of the lottery: I could win or I could lose, those are two possible outcomes, however the likelihood of those two outcomes is certainly not 50/50 (and if it were I’d be playing the lottery not trading the market lol).
As a more specific example of what I mean by behavior tendencies consider this: in a bracketed market why do traders tend to buy near the lower portion of the range and sell in the upper portion of the range? It’s because at those locations there is a greater likelihood of the prices reverting to the mean than breaking out. The market is facilitating trade around a range that it finds to be fair so unless the perception of value has changed it has a greater likelihood of rotating around that area than becoming imbalanced. I may short in the upper portion and this may be the time when the market breaks out against my position, so it is true that I may win or lose on the trade, but that doesn’t mean that there’s an equal probability of winning or losing in that location. If the same trade were to be taken hundreds or thousands of times, then it is more likely to be a profitable method than a losing one (assuming the risk and reward is also reasonable) because the behavioral tendency in that market context is to revert to the mean.
I’m not buying just because the market sold off or selling just because the market moved up a certain amount. As another example, in a strong trend, there is a strong degree of directional conviction and so it is likely that the trend will continue, however it isn’t guaranteed to continue (i.e. I don’t know for certainty whether I’m buying the top tick or selling the bottom tick). So even in a market context that has a high degree of directional conviction, the outcome is still probabilistic but it is unlikely to be 50/50. Let’s say the market is trending up, as it ticks back down it is becoming a more attractive price to buy at and a less attractive price to sell at. As long as there hasn’t been a significant change in the behavior of the participants, buying at these temporary lower prices has a higher probability of leading to a profitable trade than shorting at the same location. If we can say something along the lines of “most of the time ‘x’ happens, ‘y’ tends to follow” then the probability is likely greater than 50/50.
We don’t even need to use my examples, let’s use the long trade that you talked about a couple of weeks ago in the webinar. Why did you buy where you did? I don’t know with certainty, but it’s likely because you thought that higher prices were more likely to follow the market activity that was being seen than lower prices. If that weren’t the case, you would’ve either waited for lower prices to buy or potentially even considered shorting if you believed that the likelihood that the market would sell off further was higher than it being bought back up. That is an assessment of probability and directional conviction.
Something else to consider is the fact that not all prices are traded equally. Some trade a lot and some trade very little, which means that there is a difference in the quality of various opportunities in the market. Knowing that means that certain opportunities intrinsically have a better probability of success than 50/50.