Fantasy Stock Market - SophiVest.com

Did you know it is possible to profit while losing a majority of your trades?  Proper trade evaluation is a very important part of successful stock trading.  Learning how to pick successful trades is key to maximizing your invesetment return while preserving your portfolio's value over time.

It is a fact that a trader will have losing trades, and a significant number of them.  But, as traders, we can apply a filter to our trades such that we select trades with the highest likelihood of success, and enough profit to offset losses from other trades.  In our money management section, we mention two of the three keys to successful trading are a defined stop loss and a defined profit target.  Detemining these points up front removes the emotion and sbjectivity from trading, which is the number one reason for failure among traders.

YOU HAVE TO WIN WITH LOSING TRADES

So, how do you go about selecting the best trades?  First, a trader will apply his analysis to the particular trade, determining the potential entry and exit prices.  Presumably, this will result in a better than random probability that the trade will be profitable, but there is still a possibility that the trade will be a loser.

One measure of a trade is the reward-to-risk ratio, that is the ratio of the trade's risk (stop-loss) to the expected exit price.  Let's look at an example to illustrate this principle.

We invest $1,000 in a stock with a stop loss of 5%, or $50, and an exit on a 10% , or $100 gain.  In this case, the reward-to-risk ratio is 2.0.  Now, how does factor into a portfolio?  The chart below illustrates the significance of this principle over the course of 100 trades of equivalent dollar amounts and assuming a 50% probability of profit.

In this example, you can see the reward-risk ratio is very important over a number of trades to long-term success because a single losing trade will offset the losses of several losing trades.  After a little math, you will find that a ratio of 2.0 allows you to lose 66%, or 2/3 of your trades and still break even.  Of course these odds improve further with higher probability of trade success.

Likewise, you can see from the chart that if you risk more than you stand to gain on a specific trade this is a losing strategy over a number of trades and is not a sustainable trading method.

Trade evaluation is one of the most important factors in stock trading, along with money management, that is most often overlooked, but is a critical factor in a trader's success.