What is the fundamental principle of the Trader’s Equation?
A trader should only take a trade if the probability of success multiplied by the potential reward is greater than the probability of failure multiplied by the risk.
What is the key difference between ‘initial risk’ and ‘actual risk’?
Initial risk is the predetermined amount a trader is willing to lose, while actual risk is the amount they actually had to risk in hindsight to stay in a winning trade.
Why is there no widespread agreement on what the ‘initial risk’ is for any given trade setup?
Different traders use different stop placement strategies (e.g., price action, money stops), resulting in varied initial risk amounts for the same entry.
According to the Brooks Trading Course, if a trader is uncertain that the probability of a trade’s success is at least 60%, what is the minimum reward they should aim for?
They should go for a reward that is at least two times their risk.
Taking a profit at two times your initial risk will always result in a positive _____.
Trader’s Equation
Name one type of ‘price action stop’ mentioned in the source material.
Placing a stop below a prior low, such as below the signal bar, the bottom of a bull breakout, or the entire bull trend.
What is a ‘money stop’?
A stop based on a fixed amount of money, ticks, or pips, rather than a specific price action level.
After a strong breakout to a new high, where do most traders agree the stop should be tightened to?
Just below the most recent major higher low.
Why do traders tighten their stops to below the most recent major higher low after a new high is made in a bull trend?
Because if the market falls below that low, the premise of a bull trend is invalidated, and the market is then in a trading range or bear trend.
How is ‘actual risk’ defined?
It is the distance from the entry price to the ‘perfect stop’—the tightest possible stop that would have avoided being stopped out on a winning trade.
When does a trader know their ‘actual risk’ on a trade?
Only in hindsight, after the market has moved strongly in their favor and a pullback has occurred.
The distance from a trader’s entry price to the theoretically _____ stop is the actual risk.
perfect
How do computers and algorithmic traders often use ‘actual risk’?
They use it to generate profit targets, such as one or two times the actual risk.
In a high-probability trade (at least 60% chance of success), what is a reasonable profit target based on actual risk?
A profit target equal to one times the actual risk.
What market behavior indicates that many computers are using actual risk to set profit targets?
The market pulls back or sells off when it reaches a price level corresponding to a multiple of the actual risk (e.g., 1x or 2x).
In a bull trend, what do profit targets create?
They create resistance, as bulls sell to take profits and bears also sell at those anticipated levels.
In a bear trend, what do profit targets create?
They create support, as bears buy to cover their shorts and bulls also buy at those anticipated levels.
When a trader ‘scales in’ by adding to a winning position, what condition should the second entry meet relative to the first?
The second entry should be at least the size of a scalp below the first entry.
If a trader buys, and then buys more at a lower price, where will they often take profits on the second entry?
They will often exit the second position for a scalp profit when the market returns to their first entry price, allowing them to exit the first position at breakeven.
According to the source, what percentage of bars on any chart are in a channel or a trading range?
Approximately 90% of bars.
When the market is in a channel or trading range, what is considered a reasonable minimum reward relative to actual risk?
A reward of two times the actual risk, because the probability is not especially high.
If a trader’s premise for entering a trade becomes invalid, what should they do, even if their target or stop hasn’t been hit?
They should exit the trade.
When is it a poor strategy to use a small actual risk to calculate a profit target?
When the probability of a much larger profit is very high, such as after a very strong breakout.
What is described as the ‘absolute minimum’ profit target that makes a trade mathematically sensible?
A profit target of two times the actual risk.
