The Win/Loss Conundrum: Understanding the Odds

When you've got trades on, you typically focus on your profits or losses. But you could lose more times than you win and still come out ahead. Learn how to use probabilities to manage your options positions.

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5 min read
Photo by Dan Saelinger

Key Takeaways

  • Understand how to use win/loss probabilities to manage stocks and options trades
  • Combine high-probability trades with money management strategies to identify trades with better odds
  • Managing your trades and being aware of the odds can help you potentially achieve long-term profitability

There’s an old joke among traders: What do you call a scalp gone bad? An investment.

It’s not just a bad joke; it’s a bad idea. And it’s not just the money, although that’s a big part of it. Hanging onto a loser is mentally draining, and it ties up capital that could be better allocated elsewhere. Plus, you’re supposed to ride your winners and cut your losers. That scalp-turned-investment is the exact opposite—it’s riding a loser because you’re too stubborn to take your lumps and move on.

Part of the issue is understanding your objectives—targets, goals, and pain points. And let’s not forget the importance of discipline in sticking with a strategy once your objective is hit (for better or worse).

It’s Like Other Things in Life

In the 1960 World Series, the New York Yankees dominated the Pittsburgh Pirates in pretty much every category. Over seven games, the Yankees outscored the Pirates 55 to 27. The Yankees also led the series in the number of hits, batting average, and pitching.

But on October 13, 1960, the Pirates were crowned national champs. Because in the World Series, there’s only one category that matters—the number of games you win—and the Pirates won four out of seven.

Here’s another one. Since the start of this nation, five presidents have been elected without having won the popular vote. Unless the Constitution is amended, the objective is to win 270 electoral votes. The popular vote is mostly a related statistic.

What do the 1960 World Series and the U.S. Electoral College have to do with trading? They underscore the importance of objectives. Place too much importance on the wrong objective and you run the risk of falling short of the underlying goal, which, as a trader, is to keep account values moving in the right direction.

Here’s a common sentiment among new traders: “Of my last 50 trades, 35 were winners, and 15 were losers. Yet, I broke even.”

Has that ever been your trading pattern? You have confidence in your overall strategy, except when a trade goes south. You get stubborn. You believe you’re right, so you hang on, or even double down. Next thing you know, that one loser has wiped out your last six winners. It’s not just a rookie mistake; even veteran traders have fallen victim to the forces of stubbornness and misguided conviction.

Remember the first rule of trading: Profitability is about total dollars and cents, not about win/loss percentages.

Looking for Good Odds

One way to keep an eye on goals? Instead of focusing on percentages, consider whether the odds are in your favor. In other words, consider looking for so-called “high-probability” trades with defined risk parameters and a risk/return profile in keeping with your tolerance.

Good odds are also about cutting your losses but letting your winners run their course. That’s the exact opposite of the trader who lets one pig of a trade wipe out the previous six winners. Say you’ve got a $10,000 account and you target 5% of risk per trade, with a risk/return of 2:1. In dollar terms, that equals a max risk of $500 and a max return of $1,000 per trade. Suppose you made 16 trades last month following these targets, with the following results:

6 Winning Trades x $1,000 $6,000
10 Losing Trades x $500 $5,000
Net Gain/Loss $1,000

Nearly two out of three trades were losers. But because the winners ran twice as long, the account saw a net gain. Granted, this example is oversimplified. Yet, it speaks to the power of sound money management.

Merging the two—high-probability trade selection and prudent money management—is one way to look for better odds. And remember: as markets move and time passes, odds change. And whenever those odds change, it’s time to reassess whether your goals and targets are still on point.

Managing Your Odds

Whether you’re a stock trader, active option trader, or somewhere in between, the thinkorswim® platform from TDAmeritrade has the tools you need to assess the odds and help keep your eye on your objectives. Ready to put your good-odds system to work? Fire up the thinkorswim platform and follow along.

If You’re a Stock Trader ...

Brackets. Placing “bracket orders” along with your entry orders may be the simplest way to set your max-risk and max-loss points. The bracket is essentially two orders—a profit target and a stop order. When one order fills, the other is immediately canceled (called a “one-cancels-other,” or OCO, order). The bracket order allows you to set your targets just where you want them.

Trailing stops. Want to take your trade management a step further? Consider a trailing stop. It’s like a regular stop order, only more dynamic. It automatically adjusts the stop price at a fixed percent or dollar amount below or above the prevailing market price. So, if you’re long a stock and it starts rallying, the activation price increases to “trail” the new value. If the stock price drops, the activation price doesn’t change. If the stock price drops to an amount equal to or less than the current activation price, the order is activated and becomes a market order. This is one way to manage trades—by letting your winners run in a trending market (see figure 1).

how to add trendlines to stock charts in thinkorswim

FIGURE 1: TRAILING THE TREND. From the Charts tab on thinkorswim, select the drawing tool and insert trendlines on your chart. Then consider adjusting your stops as the trend continues. Chart source: the thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.


You can set your trailing stops manually (if, for example, you’re tracking specific technical trend levels). Or, if you want to be more mechanical, pull up an order ticket in thinkorswim. Under Order, select TRAILSTOP, and under Price, set your trailing parameters. As the stock rallies, the stop will reset automatically. It will get triggered if or when the price slips back to the stop level (see figure 2). But keep in mind, once a stop order is activated, it competes with other market orders and the price isn’t guaranteed.

how to set a trailing stop in thinkorswim

FIGURE 2: SETTING A TRAILING STOP. To place a trade on thinkorswim, head over to the Trade tab and on Order Entry Tools under Order, select TRAILSTOP to set the different price levels. Chart source: the thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

Laddering entries and exits. You know the frustration when you’re a hair too early on an entry point, just missed a profit target, or got stopped out on what turned out to be a head fake. To try and avoid these headaches, consider scaling in and out by laddering your prices above and below your targets. Just because you’ve set your risk parameters doesn’t mean you have to go all in, or all out, at one price. And remember, laddering into and out of positions may incur additional transaction costs.

If You’re an Option Trader ...

Although brackets, trailing stops, and order laddering can be just as effective for options positions as for stocks and exchange-traded funds, there are even more ways to manage your options trades.

Prob OTM/Prob ITM. One key to looking for trades with odds in your favor is seeking high-probability trades. You can manage the trades with the Probability OTM (an estimate of the probability of an option being out of the money at expiration) tool on thinkorswim and its inverse, Probability ITM, which estimates the probability of being in the money at expiration. You can add one, or both, of these tools to any option chain by clicking a column header, then selecting Option Theoreticals and Greeks and finally Probability OTM (or Probability ITM).

Say you’re looking at the option chain of a stock that’s trading at around $115 (see figure 3). You’re thinking about selling the 125 calls and buying the 135 calls (that is, selling the 125/135 call vertical). The Prob OTM and ITM suggest that the 125 calls have almost a 74% probability of being OTM at expiration, and the 135 calls have a 9% chance of being ITM at expiration. This is an example of a high-probability trade. Granted, you’ll need a full analysis of the points of max gain and max risk before deciding if this trade is for you. Yet, from a good-odds standpoint, there’s a high probability that both legs will be OTM at expiration (max gain), and a low probability that both legs will be ITM (max loss).

chart showing how to look up probability of options expiring ITM and OTM

FIGURE 3: OPTION CHAIN WITH PROB OTM AND PROB ITM. On thinkorswim, adding Prob OTM and Prob ITM to the Option Chain column headers from Layout can help you assess and manage a position while looking for high-probability trades. Chart source: the thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

Risk profile. As any option trader will tell you, the first rule of managing positions is knowing that the odds are always in motion. Each tick in the stock price, each tick of the clock, and each shift in implied volatility affects the odds. The Risk Profile tool (available on thinkorswim under the Analyze tab) can help you examine your positions in real time but also fast-forward to what your positions my look like at expiration—or any point between now and then. You can look at different volatility scenarios and their possible effect, not only on your profit and loss, but also on your positions’ gamma, theta, and other greeks.

Let’s face it, you can’t control stock prices. You can’t control direction, magnitude, or timing. But you can assess the odds and work to control your objectives—entry and exit points, profit and loss targets, and scenarios by which you change those objectives. Will you win more often than you lose? Maybe. But who cares? It’s not the win/loss percentage that counts; it’s long-term profitability. Diligent trade management and keeping a firm grip on the odds may just help you get there.

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Key Takeaways

  • Understand how to use win/loss probabilities to manage stocks and options trades
  • Combine high-probability trades with money management strategies to identify trades with better odds
  • Managing your trades and being aware of the odds can help you potentially achieve long-term profitability

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Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade. Clients must consider all relevant risk factors, including their own personal financial situations, before trading.

Doug Ashburn is not a representative of TD Ameritrade, Inc. The material, views, and opinions expressed in this article are solely those of the author adn may not be reflective of those held by TD Ameritrade, Inc.

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