In the world of forex trading, various money management strategies often recommended actually need to be critically examined. These ideas need to be adjusted to better fit the forex trading system. When engaging in forex trading, we often hear about various money management strategies that require the average profit per trade to be greater than the average loss per trade. Although it is easy to assume that this common advice is correct, upon deeper analysis of the relationship between profit and loss in forex trading, it becomes clear that this idea may need updating.
Profit-Loss Ratio
The profit-loss ratio refers to the comparison between the average profit and the average loss per trade we have made. For example, if the expected profit is $900 and the expected loss is $300 for a trade, then the profit-loss ratio is 3:1 - where $900 is divided by $300. Initially, this recommendation sounds reasonable. However, focusing solely on this ratio can be problematic because it does not consider the practical realities of the forex market, individual trading styles, and the Average Profit per Trade (APPT), also known as statistical expectancy.
The Importance of Average Profit per Trade
Average Profit per Trade (APPT) refers to the average amount you can expect to win or lose on each trade. Most people focus too much on their own profitability but fail to consider their APPT. APPT can be calculated using the following formula: APPT = (Win Probability x Average Profit) - (Loss Probability x Average Loss). With a positive APPT, you can expect profits over time.
Hypothetical Scenarios
For example, in scenario A, you have a winning probability of 30%, an average profit per trade of about $600, and an average loss per trade of about $300. In this scenario, the APPT is negative, meaning you could incur losses of around $30 per trade. On the other hand, in scenario B, although you have a profit-loss ratio of 1:3, the APPT is positive, meaning you can expect profits over time.
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