Author Bio

The other day I started reading Curtis Faith’s new book Trading From Your Gut. Faith was one of the original Turtles. A few years ago he wrote a book titled The Way of the Turtle about his experience as a Turtle and discussed trading system design and development at length (see my review). On my daily commute this morning Faith was speaking very directly on the subject of win rate and good trading. This is something I’ve commented on before myself, but is always worth speaking to as it trips up a great many traders in their development.

Here’s the deal. Developing traders, and even sometimes more experienced ones, get overly hung up on being right and having a high win %. This comes from two primary underlying causes. One of them is the fear of being wrong. The other is the belief that they need to have more winning trades than losing ones to be a profitable trader. Both are problematic and will cause issues.

The Need to be Right
The need to be right is something which kills traders. As Faith puts it, the whole being right thing is for forecasters and prognosticators, not for traders. Those who fixate on being right end up making bad decisions – ones that can blow up their account. They are the traders who hold losing positions way too long in hopes they’ll come back because they can’t handle the idea that they were wrong and will be forced to take a loss. Of course that often leads them to eventually panic at some point and bail on a trade at exactly the worst possible time (as many stock investors did in March 2009).

The need to have a high win rate also encourages such silly trading behavior as “hedging” in the forex market. I’ve heard many traders justify doing so as allowing them to stay in the trade so it can eventually turn back in their favor. They seem to be ignoring the fact that all they’ve done when putting on a “hedge” is lock in their loss. Like I said, poor choices – ones based on emotion rather than rational decision-making.

Odds and Expectancy
Then there are those who think that in order be a profitable trader you must have more winners than losers. Of course this is true if your winning trades are the same size as your losers. If, for example, each trade will either be a $100 gain or a $100 loss, then you need to win more than 50% of the time to expect to come out ahead in the long run. It’s a straightforward mathematical relationship. If you win 51% of the time then the expectancy for your trades is $2 ($100 x .51 – $100 x .49), meaning that on average you would expect to make $2 for each trade you do.

We can use the same math to demonstrate how you can also be profitable in the long run with a much lower win rate. Let’s use 25% as an example.

Keeping the same $100 gain/loss as above, we come up with a -$75 expectancy ($100 x .25 – $100 x .75). Not good. What if we change from a 1:1 winner-to-loser ratio to a 5:1 ratio, though? Let’s call that $500 for the winning trades and $100 for the losers. Running the figures we get an expectancy of $50 ($500 x .25 – $100 x .75). Not bad at all.

In general terms trend trading methodologies are the ones that tend of have low win % but high winner/loser ratios because they have a lot of small losses thanks to whippy, trendless markets but relatively large winners. Other systems go the other way, with lots of small winners and only occasionally a loser, but a big one.

Even for those with no real issue with being “wrong”, however, low win rate systems can be a challenge. They are subject to lots of big equity swings because the high number of losers creates lengthy drawdowns. Those can be very hard to ride out, especially for someone who hasn’t developed confidence in their system.

Focus on Good Trades
The bottom line is that you should be focused on making good trades not on making winning trades. Good trades sometimes lose money, but if you keep making them within the scope of a positive expectancy system or methodology you’ll end up ahead in the long run. Getting caught up in trying to make winning trades will almost certainly end up leading to disaster.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results.

This entry was posted on Friday, February 19th, 2010 at 6:20 am and is filed under Forex Trading. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.