“Don’t ever believe that there is a trading strategy that will not lose money”. You must have heard from many educators out there. Some of them even say that don’t believe anyone who tells you that their strategy has 100% success rate. Sounds familiar?

They are right. For most of us, aspiring traders, we should understand by now that there is no such thing as the holy grail of trading, the ultimate strategy that will succeed every time. No need to look for a strategy that make profits every time or even every day.

So how can we make money? For this, we should look at 2 main criteria for any trading strategy - the risk-reward ratio and the trade success probability. The risk-reward ratio, simply put, shows how much a person profited compared to the amount he risked for a single trade. Trade success probability tells us the likelihood of a trade winning. So to make money, our strategy should have low risk-reward ratio and low success rate or high risk-reward ratio and high success rate. Makes sense? Why not low risk-reward ratio and high success rate? Well, that is the ideal case. And I am still in search for such strategies. Just to clarify, when I say high risk-reward ratio, 3:1 is high, 2:1 is high. When I risk more than what I profit, I consider it high (ie, anything more than 1:1).

According to Chris Perruna:

“If my trades are successful 40% of the time and I realize
an average profit of 20% but I lose an average of 5%, my
expectancy is $625 per trade.

(0.4 x $2,500) - (0.6 x $625) = $1,000-$375 = $625

I lose 60% of the time yet I show a profit of $625 per
trade. If I have a system that produces 65 trades per year,
I would realize an annual gain of $40,625 (hypothetical
scenario).”

So Chris can still make money with a strategy that has a success rate of 40%! Expectancy is a management concept that you can read more about from Chris’ blog or Dr. Van K. Tharp’s books.

I prefer strategies with low risk-reward ratio and low success rate. Why? Well, if I really must choose that is. Of course, I would prefer a strategy with both low risk-reward ratio and high success rate and I will be constantly enhancing my strategy to achieve that! In the mean time, strategies with low risk-reward ratio and low success rate allow me to build my trading psychology. Imagine winning 2-3 trades in a row and knowing that the next loss will wipe your winnings away. You are back to square one. Every trade entry comes with some degree of analysis and commitment. Each and every one should be cherished and not entered with the notion of: “well, I will lose this profit in the next loss anyway…” or “I’ve got to make 3 wins to make back my loss this time” etc. It is sad. What do you think?

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