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{| class="wikitable"
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!
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!
== Chapter 30B ==
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==== Three variables - Risk Reward and Probability ====
|-
![[File:30B-RRP-2.png|left|thumb|600x600px|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)
|-
![[File:30B-RRP-7.png|left|thumb|600x600px|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
|-
![[File:30B-RRP-8.png|left|thumb|600x600px|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
|-
![[File:30B-RRP-9.png|left|thumb|600x600px|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
|-
![[File:30B-RRP-10.png|left|thumb|600x600px|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
|-
![[File:30B-RRP-11.png|left|thumb|600x600px|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
|-
![[File:30B-RRP-13.png|left|thumb|600x600px|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)
|-
![[File:30B-RRP-14.png|left|thumb|600x600px|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
|-
![[File:30-RRP-15.png|left|thumb|600x600px|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)
|-
![[File:30B-RRP-18.png|left|thumb|600x600px|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
|-
![[File:30B-RRP-19.png|left|thumb|600x600px|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
|-
![[File:30B-RRP-20.png|left|thumb|600x600px|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
|-
![[File:30B-RRP-21.png|left|thumb|600x600px|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)
|-
![[File:30B-RRP-22.png|left|thumb|600x600px|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
|-
![[File:30B-RRP-23.png|left|thumb|600x600px|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
[[Category:LK2468]]
[[Category:How To Trade PA]]
|}
[[Category:Reviewed]]
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