I’m sure you’ve all seen advertisements of trading systems that have 95% winning trades. And traders tend to get all excited when they see a high win rate. But while having a high win rate is nice, it can also be a very misleading performance metric.
The winning rate tells you how much percent of the trades in a backtest (or real past trades) have been winning trades. So if you have 100 trades in total, and 75 of those trades closed with a profit, you have a winning rate of 75%. Now the first thing to notice here is how those winning trades are defined. Are breakeven-trades included? What about commissions? If you have 100% winning trades in the E-Mini Dow Future and each of those trades was closed at 1 tick profit ($5) and you pay $7.50 per round turn, you actually lost money even if you hit your profit target 100% of the time.
Which leads us to the next fact. And that is that without knowing how much money was made on the winning trades vs. the losing trades, the winning rate is completely useless. Here’s an extreme example. Let’s say you have 90 out of 100 winning trades, a winning rate of 90%. Sounds great right? But what if on average you had an average profit of $100 per winning trade ($100 x 90 = $9000) but an average loss of 1000$ per losing trade ($1000 x 10 = $10000)? Right you have lost $1000 even with a winning rate of 90%. Of course this also works the other way around, if you only have 10% winners, but those are 10 times the size of your 90% losing trades, you’ll come out ahead!
Here things get interesting from a psychological point of view. Most traders are not ready to trade a strategy that only wins just 10 out of 100 times. Even if it’s numbers look amazing in the long run and it’s a really good system. Most traders simply can’t deal with this as it’s going to have long flat periods and you can easily have 10 and often 20 or more small losing trades in a row.
On the other side usually the drawdowns will be much steeper trading a system with a high win rate. When it finally hits those big losing trades, months of profits can be destroyed within a single day.
So to sum this up, the winning % is a key number to watch out for but it’s far less important than most traders think and without additional information completely useless. So you shouldn’t get all excited if you see a very high winning rate right away.
All of the 99% winning trade systems that try to capture a few pips on each trade I’ve seen in the past have blown up sooner or later. And any such systems that will come up in the future will end up in the same way. It’s always a ticking time bomb and the longer it’s been running and making money - the higher the odds are it will implode soon.
CFTC RULE 4.41 - HYPOTHETICAL OR SIMULATED PERFORMANCE RESULTS HAVE CERTAIN LIMITATIONS. UNLIKE AN ACTUAL PERFORMANCE RECORD, SIMULATED RESULTS DO NOT REPRESENT ACTUAL TRADING. ALSO, SINCE THE TRADES HAVE NOT BEEN EXECUTED, THE RESULTS MAY HAVE UNDER-OR-OVER COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFIT OR LOSSES SIMILAR TO THOSE SHOWN.
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