Saturday, October 12, 2013

Making more by losing more???

Since the equity markets hit their highs in mid-May, my own win rate has fallen from around 50% down towards the 40% level. These are the two edges of the ranges I have experienced over the years, although more often than not its been up close to the 50% level. Of course, when isolating smaller time periods the fluctuations in the win rate can be wider - I've experienced anything from as low as 20%, up to 80% over the course of a month or so.

These ups and downs are all part of a trend following strategy, and can often be tied into the general market conditions. The drop in my own win rate over the last 3 or 4 months coincides with a wide ranging consolidation pattern (i.e. a lack of a trend) shown in many of the world's major indices.

Curiously though, in the same period the profit factor (average win compared to average loss) has gone up. While the overall number of wins has fallen, the size of those wins has gone up. This has resulted in an increase in the average expectancy per trade.

So, even though I'm losing on a higher number of trades, I'm making on average more money per trade.

Some traders simply refer to win percentage as the be all and end all, which is a dangerous policy. I believe this has its roots in the desire for a trader to be proven right (trading his opinions) rather than trading on facts (price action). I know of traders with lower win rates than mine, who are consistently making money.

How do they do this? Simple - when they are wrong on a trade (the proof is that the trade is showing a loss) they get the hell out. By the same token, when they are right on a trade (and are making money), they keep hold of that position until such point in time that an exit signal is given.

One other way to destroy the expectancy that a trend following system gives you is by cutting the winners short. Some traders seek comfort in banking small profits, for fear of losing what profits they have made, yet they are envious of the big gains that can be made by riding a significant trend. 

To achieve that level of success, the mindset of the trader has to change. This can be for any number of reasons, but principal amongst them is risking too much of their equity on a trade.

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