The Trend Trading Blog

Trading Trends Across Stocks, Forex & Commodities

Would You Trade this Strategy?

Backtested equity curve

I was recently having a conversation with a newbie trader about my strategy’s win rate. I was explaining what I expect from my strategy in terms of statistics and probabilities. This trader was shocked that I actually lose more trades than I win. “How can you be net positive if you lose more than you win!”

I went on to explain about risk:reward ratios, average size of winning trades vs average size of losing trades etc. This trader had been taught that a high win rate was essential for success, i.e. more than 50%.

Below is a backtested equity curve for that strategy (not compounded – i.e. profits were not reinvested) over the last 10 years. I’ve purposely cropped out the equity value axis as to not skew your decision.

Would you trade this strategy based on this equity curve?

Most would say yes, but like any strategy is doesn’t come without its drawdowns and frustrating times. This is obvious by the fact that the equity curve is far from linear. Unfortunately this is reality.

4 Fears of Trading

In trading people don’t want to be wrong. Its an ego thing. Losing a trade is associated with failure by society. However there are plenty of traders who are right on their trades more than 50% of the time but still are net negative. This is down to their losing trades being larger than their average winning trade.

The fear of being wrong is one of the 4 fears in trading. This fear often causes traders to obsess unnecessarily over their win rate and not enough about their risk:reward ratio.

The other fears are:

The fear of missing out – this causes traders to overtrade or chase trades, even when their trading edge isn’t present.

Fear of leaving money on the table – this often causes traders to take profit too early.

The fear of losing money – again this can cause traders to take profit too early or not take a losing trade when they should, i.e. move stops further away from price.

My Swing Trading Strategy

Something many traders do not do is thoroughly backtest their strategy. A big mistake. Doing so means that I can confidently trade my strategy day in day out without hesitation. I know over the long term I will take money from the markets, even if I do have losing periods just like EVERY other successful trader.

*Note this is a different strategy to the strategy I posted about earlier this year.

The Statistics Don’t Lie

My strategy testing covers 791 trades over the last 10 years in US stocks only. Granted, since 2009 we have been in a bullish market in US stocks, but I have risk allocation rules that would stop me trading to the long side in a bearish market.

I measure my average winning and losing trades in R Ratio. R represents risk. I risk 1% of my account equity per trade. In this case a 2R winning trade would mean I won 2x what I risked.

Here are the important statistics for this strategy:

Winning trades: 38%

Losing trades: 41%

Break even trades: 21%

Average winning trade size: 1.99R

Average Losing trade: -1R

Average trade duration:

winning: 26 days

Losing: 9 days

Break even: 15 days

A closer Look

Although break even trades are an important aspect of a strategy’s performance, we’ll look past them here to get to the win/loss ratio.

Taking breakeven trades away my win rate looks like this:

Winning trades: 48%

Losing trades: 52%

48% of the time I make an average of 1.99R

52% of the time I lose -1R

Therefore, over 100 trades (not including break even) I lose: 52 x 1R = 52R and I win 48 x 1.99R = 95.52R

95.52 – 52 = 43.52R positive.

So for every 100 trades I will return 43.52R on average.

Lets Simplify Things

For a moment let’s ignore the glamour of day trading with its high risk association and highly materialistic lifestyle. Lets ignore the intricacies of trading strategies and look at a simple coin flip.

My strategy’s win rate is close to that of a coin flip – 50/50 chance (48/52 but close enough).

If I said to you, I’ll give you £200 everytime the unbiased coin lands on heads. Everytime the coin lands on tails you give me £100.

It’s a no brainer isn’t it? You’d take that bet every time.

Putting in the work to establish your strategy’s statistics not only gives you a powerful belief that you can be a profitable trader long term. This will get you through those losing periods. Remember random probabilities with a 50/50 win/loss ratio does not mean you will have 1 loss for every 1 win. As a roulette table in a casino proves, random probabilities cause clusters of wins and losses that you have no control over.

When you fully understand and appreciate how random probabilities work with relation to your strategy a great weight is lifted. Next you need to understand your trading psychology to make sure you execute your strategy through thick and thin.

Ignore the glamour and think logically

Unfortunately many trading educators market their services based on misleading hype and straight up lies. The fact is, statistics and probabilities don’t sell, cars and early retirement do.

With that being the case, think about the content of this article and if it is something that interests you, please get in touch:

[email protected]

Thanks for reading,

Matt