Two Numbers That Guarantee Your CFD Trading Success

Understanding the relationship between two important ratios is the key to building a winning CFD trading strategy. The two key ratios are the risk reward ratio and the hit rate.

To calculate the hit rate divide the number of profitable trades by the total number of trades. The risk reward is the average win divided by the average loss. The risk reward is a measure of how your profits compare to your losses, while the hit rate measures how often your strategy is profitable.

Lotto versus CFDs

Do you really believe that lotto is the way to make money? The behaviour of millions of people would suggest that it is.

The risk is very low, lets say $10 for a ticket, while the reward is potentially huge, with first prize being many millions of dollars, say $10 million. The risk reward ratio of this investment is exceptional at 1 million to 1. There are very few investments that deliver this kind of risk reward.

But there is a problem with buying Lotto tickets as an investment strategy. It is not the risk reward, but the hit rate. If a winning Lotto ticket requires 6 correct balls out of 40 possibilities, then the odds of winning are 3,838,380 to 1.

If we were to play Lotto 3,838,380 times then we would expect to win once and lose 3,838,379 times. This means we would win $10 million once and lose $38,383,790, overall losing $28,383,790.

Winning Lotto is more about luck than probability as you may win before you buy you 3,838,380 ticket. But when it comes to building a profitable trading strategy it is not about luck it is about taking advantage of an opportunity that has a profitable edge.

Trading Lessons From A Rugby Game

In the Super 14 rugby series in New Zealand the Crusaders has been a dominant team over the last ten years winning 7 of the 10 series.

In 2008 a gambler placed a $100,000 bet on the Crusaders to win a game at odds of just 1.08. This means that if the Crusaders won the gambler would have received a payout of $108,000, making a profit of just $8,000, but if they lost the gambler would lose $100,000. This is a lousy edge ratio with the risk reward ratio of 8 to 100 and a potential big loss for a very small gain.

Despite the lousy risk reward the probability of success is very high. If the probability was greater than 90% that the Crusaders would win then this could be the basis of a profitable strategy.

If the odds were 95% then the gambler would lose only once out of 20 games so he would make $8,000 times 19, $152,000, and lose $100,000 once. His net gain is $52,000. As an investment even though the risk reward is lousy, this could be a profitable strategy if the hit rate is high enough to justify the investment.

To trade CFDs successfully it is vitally important to have a strategy that overall you expect to win because the combination of risk reward and hit rate are in your favour.