The identification of profitable trading opportunities requires not only an analysis of the markets but also an evaluation of potential reward versus risk. Although new traders tend to be overly optimistic and think they can get almost all bets correct, they will soon realise that nothing is further from the truth. Sometimes we are right, other times we are just wrong. And that is why it is very important to balance potential risk against potential reward before you make any decision, whether you are a professional trading Forex in the markets or spread betting from home in your free time.
To profit from spread betting, we don’t need to guess all trades. If we are right 50% of the time, making £100 on each good trade and losing just £50 on wrong ones, then we will make a profit. By other side, guessing more than half the trades does not guarantee success. One losing trade can erase the accumulated profit of five or six good ones, meaning that If you let your losses roll, waiting for them to turn into profit and if you tend to close winning trades at the first sign of profit, it is very likely that some wrong bet never turns into profit and end up burning all your funds. You should cut on your losses when they are small. As traders usually say:
Let your profits run, cut your losses quickly.
The most important concept when evaluating if a trade is worth executing is the potential reward-to-risk ratio. The money you expect to make should be some multiple of the risk you are taking. Traders tend to be comfortable with a ratio of two or three, never less. Assuming you are right 50% of the time, a ratio of two will result in a profit. If it happens that you are correct in less than half your trades and if you take on trades with a reward-to-risk ratio less than two, then you are at risk of losing money. The best is to consider three as the trigger level to accommodate for a worth than anticipated win-loss ratio.
The Essential Checklist for Successful Spread Betting: After analysing the market, you think the EUR/USD pair is a good buying opportunity at 1.4250 because the prospects for it rising are good.
1) Define the entry price. In this case you decided it is 1.4250. That is the buy price at which you want to enter the market.
2) Define the target price for exit. That is a point derived from your analysis. It is what you think is the target price for the asset you are trading.
3) Define a stop loss price. There is a point that does not worth the risk of continuing losing money. This point should come from your analysis. It may be some support level taken from technical analysis or a target derived from your research.
4) Calculate potential profit from the difference between the target price for exit and the entry price.
5) Calculate the total risk from the difference between the entry and the stop loss prices.
6) Calculate the reward-to-risk ratio by equating the potential profit to total risk.
7) Is there enough edge? Compare the obtained ratio to your defined target level. Remember that traders usually consider values between two and three. If the trade delivers a higher ratio than your defined threshold then proceed with it, otherwise discard it. Do not play with stop and target exit prices just to fit into the ratio you desire. If one trade does not suit your requirements, you will find another one. Just be patient. What you can do is to fine-tune the entry price to fit in the required ratio. That would mean waiting for a better entry price but with improved prospects of success.
Following these seven steps rigidly will undoubtedly make your trading more precise and analytical, and you should gradually start seeing the difference in your spread betting P&L over time.
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