December 14, 2021
Q: What do these have in common? Unicorns; The tooth fairy; Santa Claus; Politicians prioritizing the public good against their own self-interest 🡪 A: All are, of course, mythological figures.
Here’s another: Trading services and discretionary traders claiming “real” success with win rates of 99%, 93%, 87%. Good luck with that.
No discretionary trader achieves success shooting for rates like that. The only beneficiaries of these claims are those making them to people hungry to believe them.
Before continuing, note the word “discretionary.” This refers to individual retail traders, like us, like you. We evaluate charts, determine entry & exit criteria, manage trades, and manually execute them. We don’t have black boxes doing algo, high frequency trading. We’re not quants. Discretionary vs non-discretionary trading are entirely different worlds.
Here’s an obvious truth: trading is about making money, not about “being right.” In baseball, offense really isn’t about a .300+ batting average. It’s about either knocking in runs or scoring them. Of course, you need baserunners to score runs and in trading you need to be right a “certain amount of time” to be successful. But like almost everything in life, it’s not binary – it’s how much, to what extent, and how frequently.
Many traders, if we really went to the effort, could have lofty win rates – maybe not 90%, but certainly 75-80%, because that amount of time, our trades go green at some point. So if we closed those trades with stupidly low profits, they’d be “winners.” But….to what end?
In business, net results come from the sum of outcomes. You aggregate money brought in and subtract what goes out. In trading that’s Winning Trades minus Losing Trades. Winners pay for losers, and only then are there profits. But if you have $300 losses and a bunch of $50 winners, is that really the foundation of a robust trading method? Is that sustainable? In the real world, can you really be right 93% of the time, pay for your losers and run a business where losing trades are, by design, part of the recipe? It’s really insulting to one’s intelligence to put that out there.
There are three ways successful discretionary traders operate, with the latter two the most frequent.
A small number of people scalp intraday, often profiting on small moves magnified by throwing large volume at them. Either way, it’s not a life and certainly no way for most of us who love trading want to do it, especially when it’s our livelihoods. There’s nothing wrong at all doing that, but it’s impractical for most people.
Middle-ground positive trade frequency and reasonable reward-to-risk ratios
A well-planned system where the average win rate is a “realistic” percentage, and the average win-size is a “reasonable” multiple of the average loss. For example, being right 40-50% of the time & the average win-size is 2-3 times the average loss. So, for every 10 trades, here are sample scenarios:
Depending on your trading style and trading frequency, maybe you do this every month. Maybe every two week. Maybe far less often, but you trade a larger account so have more money in each trade. The numbers can be extrapolated to your personal situation.
Sometimes, especially with certain credit spreads in options trading, you may have some high probability trades with low or even inverted reward to risk. This is okay because these trades are rooted in math and facts. Not fiction and intelligence insulting marketing claims.
In baseball terms, this approach is like a singles and doubles strategy. You aim for consistency and moderate drawdowns when things don’t go right (which they inevitably sometimes will). You avoid being unduly stressed, especially when starting out with real money and then shooting at a financial target. Done right, you can make a very, very nice living doing this, or have an awesome supplementary source of wealth generation.
“And Now for Something Completely Different”
This is geared at catching fewer, but (much) bigger moves. But it is NOT necessarily high-risk, high-reward. Rather, when done right, it involves cutting off ill-performing trades very quickly and taking a large number of (very) small losses. This is often characteristic of a trend-following strategy.
These systems feature lower “trading batting averages” (win-rates), but (much) higher average wins per trade. There are often multiple “stabs” at a trade, aiming to catch the start of a big move, and trying multiple times if the setup fails but remains valid. After entry, there are sometimes add-ons to grow the position. Returning to baseball, this is like swinging for home runs. Such systems often see win rates of 15 or 20%, but average win/loss ratios of 7-8:1 and higher, sometimes much higher.
The upside is obviously mega-results when things work. The downside can be larger drawdowns, as well as being battered psychologically since as human beings we want to be right.
In future pieces we’ll talk about the elements of a good trading system and realistic win rates and reward-to-risk ratios.
But for now, we’ll leave you with this. Do you notice in both the “Realistic” and the “Completely Different” scenarios, there’s no mention of 87%, 93% or 99% win-rates?
Q: Do you know why? A: Because unicorns and the Tooth Fairy don’t trade.
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