[This is part of the series: *9 Rules On How To Become A Trader*]

Question: “*How do you become a (profitable) trader*?”

Answer: “*Predict the future*.”

Since we know that predicting the future is impossible, maybe the question should be more general:”*How can anyone become a profitable trader – when nobody has the ability to systematically predict prices*?”

The answer is actually simple.

It is encapsulated in an equation they made me work through in grad school.

The answer is understanding Expected Value.

Technically:

**Expected Value = (P1)*(EV1)+(P2)*(EV2)**

For the purpose of trading, we modify this to be:

EV = (Probability of Losing Trade)(Expected Loss on Losing Trade)+(Probability of Winning Trade)(Expected Profit on Winning Trade)

What if to start a trade, you just flipped a coin to decide if you should buy or sell?

You have no idea where prices are going and you are flipping a coin to trade.

I would expect you would be correct about 50% or the time. Right? Prices can only go up and down – and you are just guessing at it.

But you don’t do that do you?

You use a signal (please do not use your gut, never use your gut) – some sort of signal – and with that signal, you enter into a trade with a buy or sell order.

In most cases, a signal will get your profitable trade percentage to somewhere between 40% and 60%. Let’s say 55%, just to pick a number.

Now you are using a signal to trade and you have profitable trades 55% of the time.

This means that you have unprofitable trades 45% of the time – and this is where Expected Value comes into play.

If your average losing trade is -$100, and your average winning trade is $100, over many trades you will average $10 profit per trade:

**Expected Value = (45%)(-$100)+(55%)($100) = $10**

(And you are a profitable trader!)

If your average losing trade is -$122.22, and your average winning trade is $100, over many trades you will average $0 profit per trade (as this is your break-even point):

Expected Value = (45%)(-$122.22)+(55%)($100) = $0

Even at 50% chance of loss and 50% chance of profit on a trade – the answer is simple: To be a profitable trader, your average loss must be smaller than your average profit:

Expected Value = (50%)(-$100)+(50%)($120) = $10

So, look at you own trading.

What is your chance of loss or gain on a trade? What is your expected loss or gain?

Play with it.

In short, we could say that the best advice – the only advice – to becoming a trader is to have your gains be larger than your losses.

I guess that is why some say there are two rules to trading, the first rule is “Don’t lose money. That’s also the second rule.”