The Two Ways to Win in Trading

In any case, they can last months or years. The US500 index has generally trended upwards for over a century. Keep in mind, however, that past performance does not guarantee future results.

There are tons of tools that traders use to determine and confirm the strength and duration of a trend on all kinds of timeframes. These include technical indicators, chart patterns, and a host of other analytical instruments. Whereas, predicting a reversal is largely a wild goose chase.

Whether the trend you’re going to ride is bullish or bearish, try to trade in its direction and stay with it until you spot clear signs of a reversal. Then, close your position. If you're new to trading, this relatively straightforward approach to trading market momentum can help you gain experience.

It is essential, however, to recognize that no strategy guarantees trading success.

Trend-following playbook

1. Identify the trend

   • Look to see if the price is making higher highs and higher lows (uptrend) or lower highs and lower lows (downtrend).

   • Moving averages can help: for example, if the 50 EMA is above the 200 EMA, that confirms an uptrend.

2. Entry signals

   • Enter on pullbacks to support, resistance, or moving averages.

   • Candlestick patterns like a bullish engulfing in an uptrend or a bearish engulfing in a downtrend can improve timing.

3. Stop placement

   • Put your stop beyond the most recent swing low in an uptrend or swing high in a downtrend.

   • Another option is to use ATR to set a volatility-based stop.

4. Trade management

   • Take partial profits at key support or resistance levels.

   • You can also trail your stop behind swing points or a moving average to protect gains as the trend develops.

5. Exit signals

   • Close the trade if the trend structure breaks, such as when a higher low fails in an uptrend.

   • Other exit signs include moving averages crossing back against your position, or ADX dropping below 20, which signals the trend may be running out of steam.

Trading against the trend

Suppose a currency pair has been bullish for several months. The chances it will continue to rise are greater than the chances that it will reverse. Though it will inevitably reverse eventually, to predict exactly when is no mean feat even for a seasoned trader.

Mean reversion trading

Mean reversion is a structured way to trade against the trend. The basic idea is that when a price moves too far in one direction, it often comes back toward its average.

How it works

1. Spot overextension. Use the RSI or Stochastic to see if the market is overbought or oversold.

2. Check levels. Look for the price moving far away from a moving average or pushing into strong support or resistance.

3. Enter. Wait for confirmation. Enter only when the price stalls or shows signs of reversing near those extremes.

4. Exit. Aim for a return to the average: the 20- or 50-period moving average, or the middle of the range.

Risk management

• Place your stop-loss beyond the extreme in the event the move keeps going.

• Since reversals don’t always hold, keep positions smaller than you would in trend trades.

When to avoid mean reversion

• Avoid mean reversion during strong news-driven moves like central bank announcements or major financial reports.

• It also performs poorly in high volatility when false signals are common.

Risk management in trading.

1. Position sizing

Figure out how much you’re willing to risk on each trade before you start.

Formula:

• Example: With a $10 000 account, a 1% risk ($100), and a stop 50 pips away, you risk $2 per pip. That’s 0.2 lots on EUR/USD. Position sizing ensures that no single trade will wipe out your capital.

2. Setting your top-loss

You wouldn’t navigate treacherous waters without a life jacket, and you likewise shouldn’t trade without setting a stop-loss. You set it at a level, and as soon as the price of whatever you’re trading reaches that level, you automatically exit the trade. This is designed to protect you from losing all your money if the market jolts or bolts in an unexpected direction.

If you don’t set a stop-loss, you’ll be constantly anxious, monitoring the market nonstop, and may act impulsively out of sheer emotional strain and exhaustion.

It’s better than you are at sticking to your own strategy.

Just set it and forget it. It’s for your own good.

How to implement a stop-loss strategy

• Figure out where your support and resistance levels are using technical analysis tools. These are good landmarks by which to orient yourself as to where to set your stop-losses.

• If the market is volatile, give your stop-loss some breathing room and set it farther from your entry point to avoid it being triggered prematurely by what only amounts to a price fluctuation.

• Set a risk/reward ratio you can live with. 2:1 is a popular choice because you only have to win 40% of your trades for the strategy to be profitable. Keep in mind that 2:1 is just an example. There is no fixed ideal ratio. The optimal ratio depends on market conditions, your strategy, and style.

• A trailing stop-loss will adjust automatically based on certain market behaviors to cast your net wider for profit opportunities. It will also tend to suffer from the aforementioned problem of being set off by a jerk of the price under volatile conditions.

3. Expectancy and risk–reward

Profitability in trading comes from math — not just intuition.

Formula:

• Let's say your win rate is 40%, with an average win of $200 and an average loss of $100. The calculation is: (0.4 × 200) − (0.6 × 100) = +$20.

• This strategy therefore earns $20 per trade on average. Even if you lose more often than you win, a positive expectancy keeps the system profitable over time.

4. Controlling drawdowns

Managing risk also means setting limits beyond individual trades.

• One approach is to use a daily or weekly cap. If you lose 3% of your account in a day, you stop trading. This prevents small setbacks from turning into big ones.

• You should also track your equity curve. If your drawdown is larger than what’s been typical for your strategy, it’s time to reduce position size until the account recovers.

Validate your strategy: backtesting and forward testing

So you know what kind of strategy and style you want to trade with - great! Now you need proof that your strategy actually works before putting real money on the line. That’s where backtesting and forward testing come in. Both can give you data to trust your system instead of trading on gut feelings. They reduce trial-and-error, save you money, and help you stick to your rules when under pressure.

Backtesting

Backtesting means applying your strategy's parameters to historical market data to see how the system would have performed. You can code your rules into a platform (or test them manually) and run them across several years of price history. After running your backtest, look at the numbers: win rate, how your average win compares to your average loss, the size of your drawdowns, and the overall expectancy of the system. If the results are poor on past data, they’re probably not going to do any better in the future. Backtesting lets you throw out weak ideas early and keep the ones that show steady results across different kinds of markets.

Forward testing
Once a strategy looks promising on paper, the next step is to see how it holds up on the live market. Run your system in a demo account. This lets you confirm execution and timing without risking money. Then, start with small position sizes to get a feel of real market conditions while keeping potential losses tiny. This stage also shows whether your backtest was reliable or just a curve-fit to old data.

Common mistakes to avoid

Even when traders understand these two approaches (high win rate and high payoff ratio), they often trip up by making some avoidable mistakes.

1. Chasing both models at once

Some traders try to run a strategy that needs both a high win rate and a huge risk/reward ratio. In reality, most systems lean one way or the other. Mixing the two often leads to inconsistent results and frustration.

If you like smaller, steadier gains, stick with the high win rate model. If you can handle drawdowns and wait for bigger wins, lean on high reward-to-risk setups.

2. Ignoring or moving stop-losses

Many traders place a trade with good logic but then leave it unprotected, hoping the market turns back in their favor. A single sharp move can wipe out weeks of steady gains. Set a stop loss at a logical technical level and leave it alone, or use trailing stops to lock in gains if your trade has become profitable enough. Don't keep pushing the stop back either. Sticking to the plan no matter what protects you from emotional and impulsive trading.

3. Oversizing positions

Traders often underestimate how quickly large position sizes can drain an account. Even a small losing streak can cause big damage if you’re risking too much per trade. Use the 1% or 2% risk rule.

4. Getting counter-trend setups wrong

Jumping into counter-trend trades without structure just because the market looks overbought or oversold is basically like gambling. If you want to trade reversals, use a mean-reversion strategy and indicator confirmation to time it right.

5. Forgetting expectancy math

Many traders obsess over win rate and ignore expectancy. Winning seven trades in a row is meaningless if one bigger loss erases all of those gains. Profitability comes from consistent math, not winning streaks. If the average loss is larger than the average win, the strategy will bleed over time, no matter how high the hit rate looks.

6. Lacking drawdown discipline

Every strategy goes through losing streaks. Know what you're getting into based on your strategy. The mistake is hoping to win back losses with a big trade. Be disciplined by sticking to your plan and reducing how much you risk after a certain amount of losses.

7. Ignoring market regimes

Using the same strategy in all conditions doesn't work. A method that thrives in trending markets (like moving average breakouts) will fail in choppy ranges, and mean reversion setups break down during strong directional moves. Always check the regime first. Use tools like moving averages and ADX to judge if the market is trending or ranging. Match your strategy to the regime, or sit the trade out if the conditions don’t suit you.

Bottom line

Each trader must find an approach that aligns with their skills, risk tolerance, financial goals, and level of experience. As with any financial endeavor, continuous learning, adaptability, and disciplined execution are key elements for success in the challenging world of trading.

Glossary

Trend

A sustained price move in one direction. In an uptrend, the price goes up, forming higher highs and higher lows. In a downtrend, it goes lower, forming lower highs and lower lows.

Mean reversion

The idea that when prices move too far away from their average, they often swing back towards it. Traders use this concept when trading against the trend.

Expectancy

A measure of whether a strategy makes money over time. It combines win rate and average win and loss size into one number that shows the expected profit or loss per trade.

Position sizing

The process of deciding how big each trade should be. It’s usually based on account size, risk percentage, and stop-loss distance, making sure no single trade can wipe you out.

Slippage

When your trade is filled at a different price than expected, often because the market moved quickly or liquidity was thin. It can make losses bigger or profits smaller.

FAQ

What is the 2% rule in trading?

The 2% rule refers to a risk management strategy that suggests risking no more than 2% of one’s trading capital on any single trade. By adhering to this rule, traders can limit their potential losses and protect their money. For example, if a trader has $10 000 in capital, they should not risk more than $200 (2% of $10 000) on a single trade. Following the 2% rule helps maintain consistency in risk management and prevents excessive exposure to potential losses.

What is the 1% rule of trading?

The 1% rule suggests risking no more than 1% of one’s trading capital on a single trade. It’s similar to the 2% rule, but provides even more conservative risk management.

What is a trailing stop-loss?

A trailing stop-loss in trading is an order that adjusts dynamically with the price movement. As the trade becomes more profitable, the stop-loss automatically tightens, securing gains while allowing for potential further upside.

Can stop-loss orders guarantee no losses?

Stop-loss orders cannot guarantee zero losses, but they are a risk management tool designed to limit losses to a predetermined level. Market conditions, slippage, and gaps can impact the effectiveness of stop-loss orders.

What are the main stop types?

Stop order: Becomes a market order once your stop price is hit. You’ll exit for sure, though not always at the exact level you set.

Stop-limit order: Converts to a limit order at your chosen price. You’ll only exit if the market stays within your limit. The risk is that you may not get filled if the price moves past it too fast.

Trailing stop: Trails the price automatically as it goes in your favor, locking in profits while allowing the trade more room to grow.

ATR-based stops: Use volatility (like 2× the ATR) to set distance.

Structure-based stops: Placed beyond recent swing highs or lows.

Where do you place stops?

It depends on your approach. In an uptrend, a trader might put a stop just below the last swing low. If volatility is high, an ATR-based stop gives the trade more breathing space. A short-term trader might use a tighter stop, just beyond the nearest support or resistance. The goal is to set it at a logical price level, not at a random distance.

What are gaps and slippage risk?

A gap happens when the market jumps over prices, often after a weekend or major news. If you had a stop in the gap, it will fill at the next available price, which could be much worse. Slippage is similar but occurs during fast market moves when your order can’t be filled at the exact stop price. Both are normal trading risks. Closing your position before the end of the session or keeping position sizes small helps soften the damage.

When should you adjust a stop?

If the market moves in your favor, you can adjust your stop to break even so that you know you won't lose money with the trade if it fails. If it goes even higher, you can use a trailing stop to follow the price as it moves, locking in current profits. On the other hand, you shouldn’t move your stop further just to avoid it being hit if the price is going the wrong way. This lack of discipline only increases your risk and can lead to big losses.