# Setting cut loss position using Profit/Loss ratio.

Let **P** = a probability that a trading gain profits.

So the probability that the trading loss is **1 – P**.

Let **E** =an average capital gain

and **L** = an average capital loss

The overall profit ** ****( OP ) = ( P x E ) – ( ( 1 – P ) x L )** ………(0)

Now the overall profit equation is deal with three variable.

If **OP > 0** ===> we can survive in the cruel market. ………. (1)

If **OP <= 0** ====> It is a time to adjust our trading decision. ….(2)

It sure that we need to stay survive in the market so we focus on (1)

**OP > 0**** **

or

**( PE ) – ( ( 1 – P )L ) > 0** …….. from (0)

Assume that we can control that **E = 3L**

or

average profit is equal to three time the average loss

so

**3PL – L + PL > 0**

**4PL – L > 0**

**4P – 1 > 0 ***

**4P > 1**

**P > 1/4** …………….(4)

From (4), we can see that if we can control the average gain to three time of the average lost, the probability that we buy a right stock = 0.25 is enough to be survive in the market.

Now, the new question is how to control the average gain/lost.

Let’s see.

If a stock A’s price is 100

We expect that the price should be 130 ( from fundamental or technical or whatever )

So the maximum profit = 30

Then we set the cut lost point to 10 point (** ****E = 3L** )

The cut lost point is 100 – 10 = 90

The last thing to do is make our probability to buy a right stock to be more than 25%. Is it so hard?

* because L is always a positive number so we divide both side of the inequality equality

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