Closing the trade at the most favourable price level is equally as important as getting into the trade at the right time. In the end, the price level at which you get out of your position and exit the trade determines the overall profit or loss of your trade. In this article, I’ll shed some light on the psychology of profit targets and the probabilities game of every single trade.
Every trade has a random outcome
When you enter a trade, you need to be aware that its outcome is almost completely random. Even the best professional traders at investment banks have a winning rate of slightly over 50%. This means that we can’t control the outcome of a single trade; it has an equal probability of being a winner and a loser.
This is where numbers come into play. Although every single trade has a random outcome, traders can gain an edge with a large enough sample size by taking high-probability trades and utilising strict risk management rules. Understanding this is probably the biggest barrier that traders have when thinking about profit targets.
The fact that the previous trade had a profitable outcome, combined with the same trade setup on a new trade, doesn’t mean that the new trade will be a winner again. However, human psychology tends to connect those events in a way that produces certain outcomes out of random events. Although markets do show signs of predictable behaviour by forming downtrends, uptrends, and certain price patterns, it’s crucially important for traders to understand that each trade’s outcome on its own is a random, uncertain event.
That being said, traders do make consistent profits over time in the markets by sticking to the following two understandings. The first one is that traders can gain an edge over the market by sticking to a high-probability trading strategy over a long enough period of time and a large enough sample size of trades. The second understanding is that each trade we take has a random and uncertain outcome, and has an equal probability of being a winner or loser.
Expectation is the enemy of trading success
Once you fully understand the fact that each trade has a completely random outcome and that we can’t control the market in any way, you’ll find it easier to accept losses and will not have any expectations concerning the trade’s outcome. Once you completely embrace this fact, you’ll feel immediate relief and you’ll stop chasing the market for winning trades.
Take a look at the chart above. The price reaches close to a resistance line, giving two possible outcomes to the trade: the price will either break the resistance line and go up, or retest the resistance and go down. If your trading strategy is well-rounded and combines fundamentals with technicals, you may have a slight edge in predicting what the market will do next. However, even with a 20% edge, there is no way to know exactly what the outcome of this single trade will be.
You know that over a large enough number of trades, you’ll have an edge over the market and will eventually end up profitable. This state of mind will eliminate any emotions in trading by eliminating expectations, which in turn will make you a better market analyst and trader. Whether or not one single trade is profitable is not in your hands. You only know that, after a series of trades using a high-probability strategy, you should eventually make a profit.
Casinos have a similar approach. They know that the house always wins in the end after hundreds or thousands of games, but don’t know if a single roulette game will be a winner or loser for them.
The best way to approach profit targets and trade exits
What is the best way to trade profit targets and trade exits if each trade has a random outcome and the market can’t be controlled? Obviously, the first step is to have an effective trading strategy that has the potential to be profitable over a certain number of trades. Price action strategies and strategies based on fundamentals (for longer-term trades) have a proven track record if executed in the right way. Whatever you base your trading decisions on, you need to consistently follow your entry and exit rules to see positive results in the long run.
That being said, once you open your trade and set the Stop Loss and Take Profit targets, you should leave the position alone. Known as “set and forget”, if we can’t control the market there is no reason to interfere after the trade has already been opened. It will either hit your Take Profit target or Stop Loss, and if you don’t have any expectations about that particular trade (as mentioned above), you’ll be totally indifferent to the outcome.
There is no way to even know how much the position will go in our favour. It can miss our target by a few pips and go against us, while an experienced trader may occasionally use their gut feelings to exit a trade at the most favourable price.
Human psychology pushes us to be right about any decision we make. The same applies to trading. Traders try to get all trading decisions correct, and get upset once a “perfect” trade setup becomes a loser. However, the markets don’t function that way and there is no sense in chasing the market. As discussed in this article, there are two basic understandings that traders need to understand and embrace; first, traders around the world do make consistent profits by sticking to an effective trading strategy and utilising their trading edge over a high enough number of trades. Second, every single trade has a random outcome and almost an equal likelihood of becoming a winner or loser.
Even professional traders have a win rate closer to 50% than you think, meaning that winners and losers are almost equally distributed. However, it’s consistency, risk management, risk-to-reward ratios, and being very patient about losing trades that brings in profits over a large sample size of trades. The earlier traders understand that they can’t control the market in any way; the better it will be for their bottom line.