Saturday, September 07, 2013

Focus on expectancy, not win rates

Some people tend to get fixated on their win percentage when trading. For example, people like to say "I'm right 90% of the time". I can distinctly remember a discussion that was being had on a UK bulletin board a couple of years ago, and one individual pointed out to me that "...your winning trade ratio is under 60%. I can't take anybody seriously with an average like that."

What this individual failed to understand is that, win percentage is only one factor to take into account when trading. You also need to factor in the average size of your winning trades, and the average size of your losing trades. This creates the overall expectancy of the system.

Trend following systems generally have a win ratio of less than 50% - my own win percentage is currently around the 43% mark. Yet the size of my average win is almost 3.7 times bigger than the average loss.

Win rates can fluctuate depending on the current market conditions. When the conditions are right, I can make a profit on 9 out 10 trades. Yet, when conditions are volatile and not suited to trend following, I may only make a profit 20% of the time. As an example, it was a lot easier to get a high win rate in the period from January through to mid May 2013, than subsequent to that. That is due to the change in the market conditions.

While I am not happy about taking losses, I can accept them - it is all part of the game. Keeping losses small means there are no positions lingering in my portfolio. One poster on that particular bulletin board stated that he had been holding a losing position in another stock for 9 YEARS! 

I get out as soon as I can, and move on - sometimes after only 24 hours. Another losing trade brings me closer to a profitable trade - maybe a big one, that will cover a whole bunch of losing positions and still leave me a clear profit.

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