Thursday, April 24, 2008


Making money in the markets has almost nothing to do with how often you win - but everything to do with how you manage your risk.

Repeat this to yourself every time you invest in the market until it becomes ingrained in your thought process.

Why? Have I lost my marbles? How can you make money in a market if you're wrong more than you're right?

The answer is simple, and the proof is mathematically certain. Let me show you ...

The Nature of Risk Equilibrium: The stock market is a dynamic structure that ebbs and flows pursuant to the forces exerted upon it by investors.
Trader A makes 10 trades. Nine are losers - dead wrong each and every time. Only one trade is a winner. Sounds like a pretty lousy track record, right? After all, Trader A was wrong 90% of the time!

If that's how you see it, change your thinking right now. Because making money in the markets has almost nothing to do with winning all the time.

Rather, it's the magnitude of the winnings when you are right that counts.

Trader A lost $200 on each of those nine trades (including all costs and commissions). Net loss on the nine losers: $1,800.

But Trader A let his one winning trade run, ultimately netting a huge profit of $3,000.

So how much did Trader A make on those 10 trades? Nine losers for a net loss of $1,800, plus one winner worth $3,000. Total net profit: $1,200!

Imagine that: Trader A was wrong on 90% of the trades - taking losses on nine out of 10 trades - yet still netted a profit of $1,200!

Now, let's compare that to Trader B who claims that nine out of his 10 trades are winners - a 90% win rate. Trader B makes $200 on each of the nine winning trades, for a net gain of $1,800.

But on the 10th trade, Trader B fails to control his risk and loses $3,000!

Result for Trader B: Nine winning trades for a net gain of $1,800. One losing trade for a loss of $3,000. Net result: A $1,200 LOSS!

So while Trader B was right 90% of the time and produced nine winners, he lost $1,200! Get the picture?

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