Why a 70%/30% win/loss ratio is a mirage
This is part 1 of a two part series. (This post was written on August 20.)
I am going to be brutally frank from the start of this post – people who seek a high win/loss ratio do so because of their emotional/psychological inability to handle losing trades. Pure and simple! Sorry folks – the truth hurts.
If you are one of these people, you have probably already discovered that there is not a lack of con artist scammers who want to sell you the very thing you seek. You have all seen the web site headlines and email ads:
- Triple your money in a year with this easy to learn and use system!
- The Winning Formula – The System that is Right on 80% of Trades!
- Turn $20,000 into a Million!
- Money back guarantee – win big on 70% of your trades
Not only do the scammers promise a 70% or 80% win/loss record, but they claim their profitable trades are often big winners.
If you are one of these scammERS, you belong in a jail cell (perhaps you are already in one). If you can prove to me that the 80/20 system you are selling has traded a real account initialized at $100,000 or more for three years with the performance you claim (with brokerage statements and tax reports), I will help to make your name famous. I don’t expect a lot of response on this one.
If you are one of the scammEES, well, I am not sure what to say to comfort you. But, I can present you with facts.
Trading is basically a business subject to statistical probabilities. The entire enterprise will comply with probability theory. A trading system that lives up to the claims of the scammers (an 80/20 win/loss ratio with big wins) has an asymmetrical profile that is so many standard deviations away from the mean that it is not worth unpacking the data for you. You will just have to trust me on this.
Microsoft’s Excel program can be used generate random numbers (just Google “Excel random number generator). This program is indispensible for traders with a real bent for risk management protocols, win/loss sequencing, bet size and the like. Basically, this program will simulate a trading program when the assumptive variables of the program are entered (such as win/loss ratio, win/loss values, risk levels).
I ran a simulation on the 70%/30% win/loss ratio. Here are some of the data produced by the simulation I ran.
- 70/30 win/loss ratio
- $.43/$1.00 win/loss values (if an average winning trade is $430, an average loss will be $1,000)
- 100 trades per year
- 10% of capital risked per trade — I used this number because it seems to be touted by the same folks who want to pick your pocket to sell you a black box system
Under these assumptions, in five years a $10,000 account grew to $3.1 million. However, during one sequence of trades, the account experienced a 46 trade peak-to-valley-to-new peak drawdown of 55%. Have fun with that one!
Let’s change the assumptions. Let’s say the bet size is 6% of capital per trade, but the average winner is equal to the average loser (good luck with that one). Under these assumptions the $10,000 account grew to approximately $150 million in five years. Now, what’s wrong with this picture? What a deal for a $249 black-box trading system courtesy of Mr. Scammer.
Here is the reality, folks – a 70/30 win/loss ratio is not available to us mortals. Am I saying that a 70/30 ratio is impossible? No – I have known a few people with this type of ratio. I was mentored by a man with something like a 75/25 ratio whose average profit was substantially higher than his average loss. This man was a trading superman, a genius, a one-in-a-million. Few people are born with such a gift from above. Scammers using key Google ad words and email promotions do not have the gift.
So, what is realistic — what is possible, in terms of a win/loss ratio?
Sorry, these are totally the wrong questions. Stay tuned for Part 2. When? Not sure – I have not written it yet.