"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.
~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ 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%.
This shows clearly the difference between tactical and strategic thought (and trading). Based upon combat logic, (Art of War, Book of Five Rings, etc) In war, there is tactical thought, and strategic thought, and planning. You can think of tactical thought as this battle, or this trade for our purposes. Strategic thought is the long term, overall plan to reach an ultimate goal. If you look at Vietnam as an analog, the US never lost a battle on the field. The tactical thought was, for the most part
If we use the Vietnam war as an analog, the tactical thinking was sound. The US never lost a battle. However, the strategic thought was unsound. Where the US was focused on winning every battle, its' strategic goals were never clearly defined, and therefore, impossible to reach. Tactical planning and goals should ALWAYS be defined in support of strategic goals. If a tactical plan does not move you forward towards your strategic goal, then it should be rethought until it does. Taiwan_Bear has exemplified this extremely well. He has shown that a focus on long term strategic planning is what wins. There is no way to have a 100% win rate. If you follow a strategy which offers a ratio that accomplishes realistic goals, and stick to it, then over time you will reach your long term goals. The people who think this is a get rich quick scheme, quickly find themselves poor, angry and out of money. Learn, practice, back test theories, and even then, plan for losses. Taiwan_Bear showed far better than I ever could, the way to succeed in this business.
My own experience taught me a couple useful bits of wisdom. Never try to buy at the absolute bottom and sell at the absolute top, it is simply not possible or sustainable. Secondly, never chase the market, If you miss a good rise, accept it and don't chase it. The opposite is equally true. If you missed it, you missed it. Move on and wait for the next cycle.
I'm sorry for the book, but Taiwan_Bear reminded me of so many mistakes that I made for about a year before I started to have the patience to ignore the cycles I missed, and wait for the next one. I wish he had written this about two years ago.
inverseman
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@ChristopherEisele, thanks for sharing your experience on buying/selling at the extremas as well as chasing the rise. That bit me one month ago. Was watching Star Wars yesterday and Yoda's "control, control, you must learn control" line is still something I need to practice on when I see the Bitcoin values flying upward or downward at times.
ChristopherEisele
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@inverseman, Believe me, you are not alone. Panic buying and selling are the most difficult things to overcome. It is a real mental battle. It is tempting to loosen up your stops, but if you set them where they are for a reason initially, it is best to leave them where they are. You must of course constantly analyze market conditions and determine if there has been a trend change. If there has been a change, then you must react accordingly, just always be aware of not chasing a momentary spike or dive. I only try to make 3% - 5% over the course of a deal. It is difficult to see money left on the table, but it also feels good when there is a reversal and you are sitting in dollars, or whatever, and after a large downward spike you now have a great buying opportunity.
@inverseman, Don't get me wrong though, If you got in at a good price and you are up 20%, TP before the price starts to dump. Just don't buy right back in afterwards. The downward consolidation has a tendency to continue.
@ChristopherEisele, I wish I can explain things the way you do. Beautiful analogy.
You can share this article with others so more traders can benefit from it and avoid the mistakes that we've been through
ChristopherEisele
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@Taiwan_Bear, I was a technical sales engineer for 25 years. I had to explain technical concepts to business audiences on a regular basis. Analogies were my life.
olikars
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@ChristopherEisele, can you share your long term strategy and how that translates into actual trades?
ChristopherEisele
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@olikars, I am a trend trader. I watch the flow and conduct TA's from 4H up to 1D. For instance, ALGO tends to use the 50MA as support and resistance cyclically. I rely strongly on MACD, and of course parallel analysis of BTC (of course). Algo, in the recent weeks has begun to show behavior which lags behind BTC. I don't use BTC as a predictor, only that you can not trade any crypto without constantly having one eye on BTC. I have moved a lot of my position away from BTC and into ALGO for a couple reasons. First, it has outperformed BTC. Second, its cycles tend to run within a tighter period length than BTC. When you look at the MACD for ALGO, you tend to see a weakening of the buy driven volume in the MACD chart when it is beginning to top out, conversely, you also see a weakening of the sell driven volume on the other side. When you see drives outside of the trend with respect to the current SUP/RES points, compared to the 50MA, it gives you a great indicator for entry and exit points. As TB said earlier, patience, patience, patience. Drives can keep going, as can drops. (My reference to softening of buy and sell driven indicators on MACD are indicated by red to pink and green to ?pastel green? on the MACD volume indicator. Also, pay attention to cyclic high and low values on the MACD. They don't exactly repeat, but they can come close. One word of caution, if you are going long, you will find yourself holding a position for as long as a week or so. If you aren't comfortable with holding for that long, then don't do it. I have chewed my nails down to nubs and been a nervous wreck over it at times.
STOPS!, STOPS!, STOPS!. Choose wisely, this is where TB's R/R analysis is all important. You will have losses. As long as you minimize losses and maximize gains you will on average generate profit. I have also begun to recently explore dollar cost averaging via spreads, with some success. I usually target 2 or 3 percent with 25% of my position, 5 percent on 50% of my position, and 10 percent or higher on 25% of my position. Again STOPS! be careful and thoughtful when setting your stops. They will save you.
Another behavior of ALGO that I like, is that is indicates early when there is a pending trend change. If you look at the charts for the last several months, you see pull backs leading up to top outs, as well as upward reversals, so watch those wicks and doji's.
That is the cheat sheet version. As I always recommend to anyone, do on paper trades before entering a currency you are not used to. Only after you find yourself "getting it" and generating profit on paper, and your TA's becoming accurate, then start putting real money in the market. Once you are comfortable with your analysis, and it proves to be mathematically accurate, you have to reach a point where you trust yourself. Remember, as much as 90% of the market loses money, there is also a lot of market manipulation.
If we use the Vietnam war as an analog, the tactical thinking was sound. The US never lost a battle. However, the strategic thought was unsound. Where the US was focused on winning every battle, its' strategic goals were never clearly defined, and therefore, impossible to reach. Tactical planning and goals should ALWAYS be defined in support of strategic goals. If a tactical plan does not move you forward towards your strategic goal, then it should be rethought until it does. Taiwan_Bear has exemplified this extremely well. He has shown that a focus on long term strategic planning is what wins. There is no way to have a 100% win rate. If you follow a strategy which offers a ratio that accomplishes realistic goals, and stick to it, then over time you will reach your long term goals. The people who think this is a get rich quick scheme, quickly find themselves poor, angry and out of money. Learn, practice, back test theories, and even then, plan for losses. Taiwan_Bear showed far better than I ever could, the way to succeed in this business.
My own experience taught me a couple useful bits of wisdom. Never try to buy at the absolute bottom and sell at the absolute top, it is simply not possible or sustainable. Secondly, never chase the market, If you miss a good rise, accept it and don't chase it. The opposite is equally true. If you missed it, you missed it. Move on and wait for the next cycle.
I'm sorry for the book, but Taiwan_Bear reminded me of so many mistakes that I made for about a year before I started to have the patience to ignore the cycles I missed, and wait for the next one. I wish he had written this about two years ago.