The first step that you need to take in order to avoid the doom of negative emotions when trading is to select a system that is compatible with your trading personality. If you select a system that is wrong for you, no matter how great it is, your emotions will take over and cause you to break the system.You almost have to look at it in the way you would look at a spouse.
If your spouse has completely different interests and goals than you, things simply will not work out, no matter how great that person is.Without going too deep into it and asking you to take personality profile tests, you simply have to ask yourself one crucial question: What is going to make me react in a worse way—a lot of small consecutive losses.To clarify, think of it this way:
One type of a winning system will have more losses than gains, but the gains will be bigger than the losses. Another type of a winning system will have a lot of small gains, with a few occasional losses that are big and will wipe out quite a few gains.This is, of course, a gray scale, and there will be different size gains and losses; however, almost no system is going to be right in the middle.
It is always going to be skewed to one side or another.The reason that this is a critical component is a principle known as system trade expectancy. Many traders think that having a high reward/risk ratio is important for successful trading. This is not true at all. In order for a system to be successful, it needs to have positive expectancy. Essentially,expectancy measures how much you should expect from every trade that you make with a trading system.
If you have historical data of trades on a system, you can calculate expectancy as follows. Take the average historical loss and multiply it by your losing percentage. Then take that number and subtract it from your average historical win multiplied by your winning percentage.The main purpose of the expectancy formula is that it should tell you how much you can expect to make on a trade over a large enough sample size of trades. Obviously, you want this number to be positive and large enough to make you want to trade the system.
You can relate this formula to trading binary options in a practical way.Let’s look at two examples: One would be most compatible with a trader who prefers many consecutive wins and a few large losses, and the other is more compatible with a trader who would prefer more small losses and compensating for them a few large wins. Let’s look at each of these examples.
More Small Wins and Fewer Big Losses:Let’s say that you are buying deep‐in‐the‐money options. As you know, with these options you are paying a fairly high premium. If you are correct, you will receive $100 per contract at settlement. This means that you will earn only a small percent return on your collateral.
However, you have a higher chance of winning on the trade because you win as long as the underlying does not drop below the strike price of the option. If you hold until expiration and lose, you will lose much more than you make on your winning trades with this approach. Therefore, this approach has a low reward/risk ratio but a high accuracy.And this is one type of trade that you can get into if you prefer to win more frequently than you lose but are okay with having a few larger losses.