A beginner often waits for many bars before finally finding a trade that will work. That trader then watches the market reverse quickly stopping out the position, and it occurs to him that he would have made a profit doing the exact opposite. Over time, it dawns on the trader that it is important to respect the institution taking the other side because 40% to 60% of the time, that institution will win and he will lose. That is the nature of trading.
During strong breakouts, the probability of continuation can be 70% or higher, but the stop is then far away. Remember, there always has to be a reason for an institution to take the other side. If you have high probability, then it has a big reward relative to risk. Other than during strong breakouts, the probability that the market will move 10 ticks (or any number) up before going down 10 ticks is between 40% and 60%, and if the trader always goes for a reward that is at least twice the risk, he will have a positive trader’s equation. This means that he will make money over time if he manages his trades correctly.
In general, traders should look at any market as either a stop-entry market or a limit-order market. Also, traders should assume that every limit order is the opposite side of a stop order. If you buy on a stop at one tick above the high of the prior bar, you should assume that the institution taking the other side entered with a limit order. If you shorted with a limit order at the high of the prior bar, you should assume that the institution that bought the other side of your trade entered with a stop order.
You never know who took the other side of your trade or how or why they did, but it doesn’t matter. As a trader, you should look at every breakout, even a breakout above or below the prior bar, as likely to succeed or fail. Once you have an opinion, if you can structure a trade that makes sense, then you can take the trade.
For example, if there is a small bull flag at the top of a trading range, you know that most breakouts fail, and therefore the probability is that the sellers will overpower the buyers at the high of the prior bar. This means that you can consider shorting with a limit order at the high of the prior bar. A bull might be willing to buy with a stop order above that bar, taking the opposite side of your trade. However, he knows that the probability of his trade is small. He is willing to take it because he also knows that if the breakout succeeds, the rally might go for at least a measured move up. The result is that he took a low probability trade (one where he knew that he would probably lose), but since the reward was so much greater than the risk, the math was still good.
Although the math is good for either side of the low-probability trade, high-probability trades are easier to manage. This is because low-probability trades often look bad for many bars after entry, and the trader is constantly tempted to exit. If he exits too many trades before they reach their targets, he will not get those infrequent big wins that are needed to offset his frequent small losses.
The high-probability side is easier to manage because, by definition, you will make money on most trades. This means that you can mess up occasional trades and still end up profitable over time. This obviously sounds great, but it is not easy. Remember, there has to be something in it for the other side. If you get high probability, that other side gets big reward relative to risk. This means that you get small reward relative to your risk.
In the EUR/USD, if you are buying a strong breakout on the five-minute chart, and you enter on the fourth bar of the breakout, your stop is below the low of this four-bar rally, which might be 50 pips (ticks) away. Also, because you are entering late, the profit that remains in the trade is less, and your reward might be only as big as your risk, instead of two or more times greater.
Some traders prefer high-probability trades, which is mostly due to their personalities. They are basically scalpers. The best scalpers can win or breakeven on 90% of their trades. However, most successful traders cannot trade this intensely long term and prefer to take trades where the reward is at least twice as big as the risk. This means that they win about 40% of the time. Their initial stops might get hit about 40% of the time, and the rest of the trades are small losers and winners that mostly offset each other. Because the reward is at least twice the risk, they have a solid mathematical approach to trading. This is the type of approach that most traders should use. In general most of their entries should be with stops, buying at one tick above the high of the prior bar and putting a protective stop one tick below the bar, or doing the reverse for a short.