Have You Been Doing the Maths?
New traders rarely focus on maths.
And if they do, it tends to be primarily a focus on the winning percentage of their trades. In fact, if you tell your friends you are a trader, one of the first questions they ask is “What is your winning percentage?”
And if you answered 70 – 80% you’d likely get a fair number of approving nods and pats on the back. Yet if your losses were huge compared to your wins, you could actually be losing money with an 80% win rate.
So win rate is only a small part of the mathematical equation when it comes to being a successful trader. What you should really be getting your calculator out for is estimating risk vs reward. This is the calculation that is going to make or break you as a trader.
As an example, if you are position sizing correctly with your set ups and risking $1 to make $3. Then to break-even, you only need to have a win rate of 25%.
Risk Vs Reward
Considering this is a risk vs reward goal worth aiming for, it does put into the shadows the importance of win rate.
Even if your trade set up is only looking at risking $1 to make $1, then you can still break-even with a win rate of 50%.
At the other end of the scale, what if you were focusing on finding set ups that are risking $1 to make $5. Then to break-even you would only have to win 17% of the time.
Now I’m not saying win rates should be ignored. They are certainly worth keeping track of. Yet what we have shown here with some simple maths, is that win rates are nowhere near as important as risk vs reward calculations.
We can all scalp for tiny profits in our trading. And bump our win rates up to what on the surface looks to be impressive numbers. Yet lots of tiny profits will quickly evaporate with just one or two large losses. And that’s not taking into account brokerage costs.
On the flip side, let’s look at traders who are disciplined with their risk management. And who consistently look for set ups that provide an average risk vs reward of 1:3. Then these traders accounts are likely to be flush with profits with only a 40% – 50% win rate.
Maths doesn’t lie.