Probability Theory In Forex Trading
Today marks the launch of a new part of the blog titled “Forex and Probability Theory,” which is devoted, as the name suggests, to the application of probability theory in Forex trading.
And, in the first article of this part, I’d like to discuss the broad principles of probability theory, but first, I’d like to touch on the issue of information collection, i.e., statistics. This is a common misapprehension.
Statistics for the Forex market
Statistics is a kind of social science that gathers, processes, and analyzes numerical representations of data relating to a wide range of mass phenomena.
In general, it gives significant coverage of the events and processes under investigation, hence acting as the most dependable and right method of appraising reality.
No, after all, no sensible businessman would launch a new shop or manufacturing without first doing marketing research and collecting statistical data.
The same is true for production: if a shop is required in this location, how many inhabitants live there, whether it will be in demand, competitive, what profitability it is expected to generate, when to pay off, and so on.
It’s pure folly to open for a moron.
What should you anticipate if there is no data?
Statistics have a huge edge.
So, why are so many people ignoring it in Forex?
You haven’t considered why so many poker players go on to become great traders.
A good poker player evaluates all the odds of a transaction up to a tenth of a percent, and if the likelihood of a favorable result climbs in his favor, he continues to play boldly since he knows statistically he has a better hand.
The same is true in Forex. Any method must go back in time, gather all of the data, and assess the likelihood of all conceivable possibilities.
It is impossible to create an effective trading strategy without first studying historical data. Any trading technique begins with a review of previous price performance.
The most common mistake made by new traders is neglecting to pay careful attention to data. I’ve noticed that virtually no one gathers statistics.
Consider any trading strategy that is being adopted by a large number of beginner traders. They study history for hints such as “it often returns profit,” “this is a smart technique,” and then start trading.
Nobody considers how successful agreements outnumber poor ones.
As a result, they trade at a loss and, worse, drain the deposit.
They did not calculate the likelihood of the occurrence.
Why do some traders profit from the same strategy while others lose money?
Mathematicians and physicists, or at the very least those with a mathematical mentality, are the most effective traders, according to observations. This is not by chance. The financial exchange’s price behavior is determined by complicated statistical models, that is, models based on mathematical statistics that in some ways depend on patterns of random price behavior (probability theory).
The probability of an occurrence is a numerical representation of the objective likelihood of an event happening or a measure of the likelihood of an event occurring.
P ( A ) = m / n ;
Where m is the number of cases of favorable events A, n is the number of all cases
We must keep in mind that we are estimating the probability of an event occurring. The chances are always 50/50 on Forex; the price might move in equal parts up and down from the level of our open transaction.
Consider the following example. Assume you discovered a lucrative technique in your view, and its creator states that it produced seven transactions out of ten in a bad year, the stop-take-profit ratio is 1: 1. However, what about now?
After a cursory examination of history, you conclude that it is extremely lucrative at the moment and immediately begin trading on it.
And if it fails, if the approach fails, you will suffer a loss. Why? You just need to be more meticulous in your approach to statistical data collecting.
Below is an example of what data I collect:
The total probability of a plus is…%.
The likelihood of a plus if the entry is carried out along the trend is…
Against the trend-..%
The probability of taking profit with a sell signal is…
Purchase—-%
The probability value depends on the trading session (if trading is intraday):
Pacific (Sydney)-… %
–% Asian
% of all Europeans
–% of Americans
The likelihood of capturing 12 of the take profit with the same stop is… %.
The probability of taking a profit when the stop is increased by 5 points is…
–% ten points
15 points for -%
20 points–…
etc.
and decreasing the stop loss by 5, 10, 15, etc. points. This allows you to choose the optimal stop size.
The probability of taking a profit if the deal is 10 pips in the red is…
–% 15 points
20 points-….
etc.
The probability of break-even if the position is in the red by 10 points is…
–% 15 points
20 points-….
etc.
If the position is in the red and the chances in percentage terms are minimal for taking profit, you cannot wait for the stop loss to trigger and close the position earlier.
The probability of taking a profit if the position is already in positive territory by 10 points is…
–% 15 points
20 points-….
etc
If the chances are high, therefore, you can top up.
The probability of taking a profit if the previous signal was false (that is, the stop loss was triggered): -… %
If there are two false signals in a row, %
Three in a row–%
etc.
How much does the probability of the next false signal increase with two successive successful deals?
Three in a row–%
four-… percent
etc.
Like that.
However, each technique is nuanced in its own way. As a result, you must compile statistics directly connected to it (entry on the first candlestick, the second, if the candlestick is bullish, bearish, etc.).
Naturally, calculating all of this across a lengthy period of history will take time, but trust me, it is producing fruit.
And, more broadly, who said you couldn’t earn money on the stock market without exerting considerable effort?
An important and fundamental concept to remember while working with probability theory is that “mathematics cannot be argued with.”
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