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Chapter 30B	Three variables - Risk Reward and Probability
Three Important Variables: Not Just Risk and Reward	Three Important Variables: Not Just Risk and Reward Traders always have to consider 3 variables when planning to take any trade: Probability Reward Risk Can also think of them as just 2 variables: Probability Risk/Reward (RR) Early entries usually have smaller risk and greater reward (good RR), but lower probability of profit Later entries often have more certainty (higher probability), but pay for it with a worse RR because the stop is now far (more risk) and less remaining profit (smaller reward)
Beginners: Afraid of Risk - did not think in terms of probability	Beginners: Afraid of Risk When trader starts out, worked hard to save enough money to try trading Account is small so Afraid of losing opportunity to see if can win big Generally take lowest risk trades Lose money because don’t understand importance of probability and that low risk trades lose 60% or more of the time Lose money because of poor management Can make money with either high probability and weak RR or low probability and strong RR if manage the trades properly
Experienced Traders: Only Think about Math	Experienced Traders: Only Think about Math They choose high probability or strong RR, depending on which gives them a better edge For example, if they have to leave soon, they might choose higher probability because these trades usually have a faster profit, even though ¡s it usually smaller (scalp) Skilled traders don’t worry too much about picking exact top or bottom Many wait for BO or pullback since probability 60% or more Comfortable with stop far away Bigger risk is cost of getting high probability
Improve the Math: 2 Ways	Improve the Math: 2 Ways One way to improve RR is by swing trading instead of scalping Swing trader takes profit here Same initial risk as scalper Average profit is bigger More than offsets slightly lower probability of profit before stop is hit 2nd way to improve Trader’s Equation is by scaling in
Scaling In: Increase Probability, but Pay for It with RR	Scaling In: Increase Probability, but Pay for It with RR Sell below pullback bar Sell more (scale in) below Low 2 sell signal bar Scaling into trade increases probability Pay for it with increased risk and reduced reward Take profits at 1st entry Breakeven on Pt short Profit on 2nd short
Bull Breakout: Increases Probability	Bull Breakout: Increases Probability Strong BO and follow-through High probability of Measured Move up, but stop is far below so big risk PB after strong BO so bull flag Slightly lower probability since TTR (and Triangle) Small risk, but low probability DB HL MTR, bottom of TR, but most TR BO fail
High Probability: Means Scalping (Weak RR)	High Probability: Means Scalping (Weak RR) If someone wins 90% of time, he is scalping Cannot get good variable without giving on others If I get high probability, you get good RR (usually small risk) This means that you lose a little and I make a little (scalp)
RR Usually Exact: Probability Never Certain	RR Usually Exact: Probability Never Certain You know risk and reward You set them when you place your bracket order Know how many ticks/pips they are from your entry price Risk = number of ticks/pips to protective stop Reward = number of ticks/pips to profit taking limit order Probability = most important, but never clear and often ignored Sell close of 2nd strong bear trend bar Stop is above top of bear leg of top of 2 bar BO Reasonable initial profit target (reward) Most traders want profit at least equal to initial risk
Deep Pullback in Bull: Risk, Reward, and Probability	Deep Pullback in Bull: Risk, Reward, and Probability Always look to the left of any BO As long as above prior low, still in bull channel, even if Always In Short Bear BO and follow-through Always In Short Double Bottom Higher Low Bulls buy reversal up Most bears exit Small BO below bottom of bull BO bar (hard to see)
How Many Bull Dollars in Bottom 3rd?	How Many Bull Dollars in Bottom 3rd? Need Reversal Up Strength of reversal up tells traders bulls stronger than bears Back to Always In Long In bottom 3rd, always an unknowable number of dollars ready to buy to create HL and Broad Bull Channel
Deep Pullback in Bear: Risk, Reward, and Probability	Deep Pullback in Bear: Risk, Reward, and Probability Always look to the left of any BO As long as below prior high, still in bear channel, even if Always In Long Double Top, LH Possible Broad Bear Channel Bulls exit 2nd Leg Trap and bears sell
PB in Bear Less Than 50%: Probability Favors Bears	PB in Bear Less Than 50%: Probability Favors Bears As long as PB stays below 50%, then probability at least 50% for bears But, below 50% PB, risk greater than reward Stop is farther than profit target Most important target for bulls Is above entire bear swing, not just last leg down If rally goes above highest stop, then no longer bear channel Then, either bull or TR
PB ¡n Bear Less Than 50%: Probability Favors Bears	PB in Bear Less Than 50%: Probability Favors Bears In top 3rd, probability is 60% for bulls to get new high and 40% for bears to get new low Reward for bears is 2x risk (good RR)
In Top 3rd: RR Favors Bears	In Top 3rd: RR Clearly Favors Bears This means reward at least 2x risk Also means probability fell to 40% In bottom half, probability favors bears This means at least 60% chance of new low
How Many Bear Dollars in Top 3rd? Need Reversal Down	How Many Bear Dollars in Top 3rd? Need Reversal Down Even though probability favors bulls, RR is at least 2:1 for the bears Always bears willing to sell In top 3rd, always an unknowable number of dollars ready to sell to create LH and Broad Bear Channel Strength of reversal down tells traders bears stronger than bulls Back to Always In Short

Risk Reward, or Risk Reward Ratio, most easily thought of as the size of your stop compared to the size of your profit target. ➟ More about RR

Pullback. ➟ More about PB

Tight Trading Range, limit order market, bad for scalping with stop orders. Most traders should wait. Usually the bars are small and tends to reverse every 2 or 3 bars, but sometime the bars can be big, however if they still reverse every 2 or 3 bars, bad for stop entry traders, making it essentially still TTR, for e.g. the TR open on 20221115.. 窄幅震荡。 ➟ More about TTR

Double Bottom, or two consecutive bars with identical lows. ➟ More about DB

Higher Low. ➟ More about HL

Major Trend Reversal. ➟ More about MTR