I love this recent email exchange with a new trader…
Email received: (We'll come in mid-stream as the earlier conversation is not relevant to this article!)
Great Lance, thanks for responding and giving me all this information.
I plan on trading highly liquid stocks and probably the intraday with the occasional swing trade. I've been out of the market for a while so I am going through some of the reads you have recommended. Come Into My Trading Room is excellent.
My problem is that I need to fine tune my studies because what I think works ends up not 50% of the time.
I love how you explain things and looking forward to buying your strategies. Your emails are great also. Thanks Lance.
Thanks. I'm glad you're finding value in my writing.
You said, "My problem is that I need to fine tune my studies because what I think works ends up not 50% of the time."
Obviously I don't have an real insight into how you're trading. But here is a different way of thinking of the problem…
What if 50% winners was enough? What if you could work to capture more of the move in those that did win. And cut the losses quickly on those that lost.
That is, accepting 50/50 and profiting from a higher win/loss size ratio.
Seriously… 50% can be enough.
I have never thought of it in that way but now I will!!
Awesome! This is one of the many important breakthroughs that we need to achieve along our path to professional trading.
It's such a simple concept. But it's hard to see. In some ways it goes against our natural desire to win. And we're bombarded daily with advertising copy promoting high win percentage strategies.
But the fact is that long-term profitability is not just a function of our win rate. Just as important is the Win/Loss Size Ratio (WLSR).
- WLSR = Average Win / Average Loss
If you achieve a 50% win rate across a series of trades you can still profit provided your average win is greater than your average loss.
In my own trading, the win rate is the least important of these trade statistics.
In a 20 trade sample I expect to achieve a win rate anywhere between 40 to 70 percent. But I aim to profit by keeping the average win greater than the average loss.
Yes… 50% can be enough.
50% winners across a whole month can be profitable, provided your average win is greater than your average loss.
50% winners across a whole year can be profitable, provided your average win is greater than your average loss.
50% winners across your career can be profitable, provided your average win is greater than your average loss.
Let's look at a few trades. Obviously eight trades are too small a sample size to really concern ourselves with the stats.
But it's eight trades that provided four wins and four losses.
And yet it profited.
Because the average win was greater than the average loss.
By all means, aim for as high a win rate as you can achieve.
But seriously… 50% can be enough.
PS. Note: This discussion has excluded consideration of commissions and other business expenses, as they will vary from trader to trader. Obviously while a series of trades may well be profitable in and of themselves, a business profit is only achieved if these trade profits are sufficient to overcome commissions and other expenses. But the fact remains, a 50% win rate will still be sufficient. You'll just need a slightly higher WLSR to cover these costs.