"The prediction did not age well" is a comment that I see frequently by many traders. These traders aim for 100% accuracy (100% win rate) as it is human nature wanting to be right and avoid the pain of going through a loss.
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Right or wrong does not matter, the key is the balance between win rate & risk reward
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However, any successful trader must breakaway from this mindset of avoiding a loss and embracing them as part of the costs of the business. While a good win rate can boost your confidence, it is inseparable from risk reward (rr). The key to consistent trading is to find your 'Sweet Spot' - ie. the ideal balance between win rate & risk reward that can ultimately give you a positive expectancy.
The 2x charts above clearly demonstrate why win rate alone is not important in trading.
The chart on the left shows the required win rate to break-even. If you have a system that can give you an average of 1:3 risk reward ratio, then you only need a win rate of 25% to break-even. This also means that if you can win just 26 trades out of 100 trades, you are in profits! Isn't this amazing? Do you still remember the below 1 hr trade that I posted back in Jan 2020? That was almost a 1:10 rr trade which means I can be stopped out another 9 out of 10 trades and I am still in profits.
(Click & play)
The chart on the right shows the inverse relationship between win rate & risk reward ratio. The higher the risk reward ratio the lower the win rate. This is because when you increase your risk reward ratio, you are either reducing the stop loss distance (ie. easier to get stopped out) or increasing the take profit distance (ie. harder to reach target). This, in turn, will lower your win rate.
There is no right or wrong approach in finding your sweet spot. Your trading system, expectations of return and your personality all have an impact on your sweet spot. It requires loads of backtesting and trial and error. Personally, my sweet spot is between 65 - 75% win rate with a rr of 1:2 - 1:3.
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Expectancy
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After you have determined your sweet spot, you can then work out the expectancy of your trading strategy. Expectancy is the process to help you to determine how much profits you should make in the long run from your trading strategy.
Here is the formula:
Expectancy = (rr x win rate) – (1 - win rate)
Let's say, if your trading system has an average rr of 1:3, a win rate of 60%, then your expectancy is equal to (3 x 60%) - (1 - 60%) = 1.4. This means your trading strategy will give you a return of $1.40 for every dollar traded.
Now, compare the above with a trading system that has a rr of 1:1 & a win rate of 90%. The expectancy is equal to
(1 x 90%) - (1 - 90%) = 0.8. As you can see from the comparison, a system that has a 60% win rate with a rr of 1:3 is much more profitable than a system that has 90% win rate but only 1:1 rr.
Hope you have enjoyed this chapter. If you have not yet read the previous 2 chapters, the links are attached below. If you appreciate what I am doing, please take a couple of seconds to press the LIKE button and leave a comment below. That will help other new traders to see this article as well.
Lots of love,
Taiwan Bear
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Key terms
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Win rate (or win ratio) is the number of winning trades divide by the total amount of trades entered.
Risk Reward measures how much your potential reward is for each dollar you risk.
Let's say if you use the 1% rule as your risk per trade, and your risk reward is 1:2 (can also be written as 2:1. Just remember the '1' generally refers to the risk), it means that you are risking 1% of your capitals for a potential profit of 2%.
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Risk management series:
~~~~~~~~~~~~~~~~~~~~~
~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~
Right or wrong does not matter, the key is the balance between win rate & risk reward
~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~
However, any successful trader must breakaway from this mindset of avoiding a loss and embracing them as part of the costs of the business. While a good win rate can boost your confidence, it is inseparable from risk reward (rr). The key to consistent trading is to find your 'Sweet Spot' - ie. the ideal balance between win rate & risk reward that can ultimately give you a positive expectancy.
The 2x charts above clearly demonstrate why win rate alone is not important in trading.
The chart on the left shows the required win rate to break-even. If you have a system that can give you an average of 1:3 risk reward ratio, then you only need a win rate of 25% to break-even. This also means that if you can win just 26 trades out of 100 trades, you are in profits! Isn't this amazing? Do you still remember the below 1 hr trade that I posted back in Jan 2020? That was almost a 1:10 rr trade which means I can be stopped out another 9 out of 10 trades and I am still in profits.
(Click & play)
The chart on the right shows the inverse relationship between win rate & risk reward ratio. The higher the risk reward ratio the lower the win rate. This is because when you increase your risk reward ratio, you are either reducing the stop loss distance (ie. easier to get stopped out) or increasing the take profit distance (ie. harder to reach target). This, in turn, will lower your win rate.
There is no right or wrong approach in finding your sweet spot. Your trading system, expectations of return and your personality all have an impact on your sweet spot. It requires loads of backtesting and trial and error. Personally, my sweet spot is between 65 - 75% win rate with a rr of 1:2 - 1:3.
~~~~~~~~~~
Expectancy
~~~~~~~~~~
After you have determined your sweet spot, you can then work out the expectancy of your trading strategy. Expectancy is the process to help you to determine how much profits you should make in the long run from your trading strategy.
Here is the formula:
Expectancy = (rr x win rate) – (1 - win rate)
Let's say, if your trading system has an average rr of 1:3, a win rate of 60%, then your expectancy is equal to (3 x 60%) - (1 - 60%) = 1.4. This means your trading strategy will give you a return of $1.40 for every dollar traded.
Now, compare the above with a trading system that has a rr of 1:1 & a win rate of 90%. The expectancy is equal to
(1 x 90%) - (1 - 90%) = 0.8. As you can see from the comparison, a system that has a 60% win rate with a rr of 1:3 is much more profitable than a system that has 90% win rate but only 1:1 rr.
Hope you have enjoyed this chapter. If you have not yet read the previous 2 chapters, the links are attached below. If you appreciate what I am doing, please take a couple of seconds to press the LIKE button and leave a comment below. That will help other new traders to see this article as well.
Lots of love,
Taiwan Bear
----------------------------------------------------------------------------------------------------------------------------
~~~~~~~~~
Key terms
~~~~~~~~~
Win rate (or win ratio) is the number of winning trades divide by the total amount of trades entered.
Risk Reward measures how much your potential reward is for each dollar you risk.
Let's say if you use the 1% rule as your risk per trade, and your risk reward is 1:2 (can also be written as 2:1. Just remember the '1' generally refers to the risk), it means that you are risking 1% of your capitals for a potential profit of 2%.
~~~~~~~~~~~~~~~~~~~~~
Risk management series:
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- Chapter 1: 1% rule
- Chapter 2: How to calculate position size?