Trading Math: Essential Concepts Every Trader Should Understand

Do all traders need to be experts at trading math? Not exactly. Traders don’t need to be math experts or math geniuses who know all the formulas. However, it is imperative for all traders to be good at basic mathematics. Why so? Because successful trading entails being good at various aspects. For example, you cannot be a successful trader if you don’t know technical analysis. You cannot be a successful trader either if you don’t understand the reading of a chart. Similarly, you cannot be a successful trader if you aren’t good at trading math, especially basics. 

It is very apt to say that human beings and mathematics have an ever-lasting connection. Almost every aspect of our life involves mathematics in one way or another. And trading also involves math and you need to understand that. Can you possibly measure your net profit if you don’t know basic math? Probably not. Given the importance of math in trading, we decided to help you.

In this article, we are going to explore how knowing simple trading math helps you in trading. We are also going to explore what kind of simple math you need to be good at. Let’s dive deep and find out what this subject has in store for us.

Trading math

Have you ever thought about why hedge funds employ PhDs? They utilize their mathematical skills to predict future developments in a stock. Additionally, they also play a huge role in algorithmic trading which covers more than 70% of the volume in trades. However, this is advanced and sophisticated knowledge that average users don’t need to acquire. But acquiring basic trading math knowledge is important for better handling of trades.

Now, if we have a look at some basic math you need when trading, there are multiple calculations you need to deal with. For example, stop-loss orders are key risk management tools. But how will you know where to put stop-loss? You need to calculate stop-loss and you need basic math for that. Similarly, there are numerous other calculations you deal with on a regular basis. We are going to explore some of them to make you understand how basic trading math knowledge transforms your trading.

1. Risk/reward ratio

The risk/reward ratio is a formula to calculate the expected profit from trade as compared to the risk of loss. It is a very key calculation in trading as it helps you to measure the viability or worthiness of a trade. However, you need to calculate it and that requires basic trading math knowledge. 

2. Return on investment (ROI)

Return on investment (ROI) is another key figure that you need in trading. It helps you to measure the profitability of a trade or investment. You can also use it to compare different investment opportunities and choose one with the best ROI. So, this ratio also requires you to do some math.

3. Drawdown

A drawdown is a calculation that tells you how much your trading capital is down from the peak. This metric also conveys vital information. But to get the vital information, you need to learn some basic math.

4. Yearly returns and win percentage

Yearly returns are another important key calculation you need to do. It enables you to evaluate your yearly trading performance. The calculations measure how much profit you made during a year. Similarly, win percentage is another important calculation that also conveys crucial information. For example, you can calculate your win percentage during a particular period of time. Both of these measures require some basic trading math knowledge. 

5. The risk of ruin

The risk of ruin is a trading concept that refers to the likelihood that a trader will lose a huge part of the trading account.  Losing such a substantial amount means the trader will be unable to stay in the game. In simple words, the risk of ruin is the chance of bankruptcy. Moreover, this is an important calculation that all traders need to calculate to measure risk and avoid it at all costs. Again, this measure also requires traders to do some trading math.

6. Profitable trade percentage

Another important calculation that requires knowledge of basic trading math is profitable to trade percentage. It is a general percentage of winning trades that give some profit. This calculation is also vital as it helps in improving trading strategies. Additionally, it also helps in finding techniques to improve profitability by improving strategies. So, this is another basic trading concept that requires some basic trading math knowledge. 

7. Stop-loss orders

Stop-loss orders are extremely crucial for successful trading. These orders are risk management tools that help you to keep your risk under control. However, stop-loss calculations require some basic math knowledge. You cannot use stop-loss orders if you cannot calculate the best stop-loss percentage. Therefore, it is important to know some math to calculate your stop-loss accurately. 

Trading math and forex trading

Although trading math is required in all types of trading, forex trading relies a bit more on math. Let’s dig deep to see why and how.

1. Pips

Forex pair prices move in pips and you cannot do forex trading without understanding it. For example, you need to know that 1 pip is equal to 0.0001 points. Additionally, you also need to know how to calculate the value of a pip. So, it all requires trading math knowledge. 

2. Leverage

Leverage plays a key role in all types of trading. However, it is of paramount importance in forex trading. It refers to a deal that results in a broker allowing traders to enter a larger position that traders cannot enter on their own. However, it is important to note that leverage is also very dangerous. It can wipe out your entire capital singlehandedly. So, you need to know all about leverage and do some math to find out what lies ahead. 

3. Position size

Success in forex trading mainly depends on your position size. There are multiple factors that you need to consider to calculate position size. Although it is a simple process, it requires some basic knowledge to calculate position size. 

Trading math conclusion

Although traders don’t need to be expert mathematicians, they need to be good at basic trading math. Trading involves a lot of calculations ranging between simple and complex calculations. You cannot handle trading without knowing some basic math. Therefore, it is important to have some basic trading math knowledge. It gives you an edge that opens the door to profitable trading. For example, if you cannot calculate a fair stop-loss percentage, you cannot manage your risk exposure. Similarly, you cannot improve your strategies if you don’t know your winning percentage. Simply put, transform your trading by acquiring some basic trading math skills.