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Why 7% is the Difference between Failure and Success in Trading
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Why 7% is the Difference between Failure and Success in Trading

  #1 (permalink)
Live Your Bliss
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Why 7% is the Difference between Failure and Success in Trading

I generated the following trials using a trading simulator with the following parameters:
10000 trials, each trial having 386 trades, with 1 to 2 Risk/Reward ratio.
Variable winning percentage.

The number of trials is set at 10000. This seemed like a large enough number to ensure robustness after monkeying around with the simulator for a bit. Setting the higher number of trials would not affect the results in a substantial way, so 10000 is sufficient.

Each trial has 386 trades. This is the simulator limit. While not huge, it is sufficient for our purpose.

The risk reward ratio is chosen as 1:2 because most trading materials / maxims recommend having larger winners than losers (and I generally believe in that maxim so it seemed like a good case study, though a similar point could be made with a different ratio).

Case 1: 33% Winning (Random)

We'll start with the random expectation percentage, 33%. If you have 1:2 risk/reward, randomly, you'd expect to win 33% of the time.

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No surprise. After 386 trades, we could up or down substantially. However, because of overhead cost, we cannot hope to be profitable winning 33% of the time at 1:2 RR.

Case 2: 35% Winning (Slightly Improved)

Suppose we improve our trading little bit past random. The results are surprising.

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Only a slight improvement in our winning percentage (2%) resulted in substantial profitability increase, not just a small one. The maximum positive and negative excursions are no longer roughly equal. The positive one is about the double of the negative one. There are many more trials that finish in the upper half than the bottom half.

Trading at 35% at 1:2 RR means that one is likely a breakeven trader. We win more than we lose... but the transaction costs will likely eat it up. While we're much better off than random by improving mere 2%, 35% is not good enough.

Case 3: 40% Winning (Improved)

Suppose we enhance our trading 'mere' 5%.

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By improving our winning percentage from 35% to 40%, we moved out of being break-even to clearly winning. Winning 40% will cover our overhead, and then some.

Consider the ratio of maximum positive to maximum negative excursion.
For 33% winning, the ratio is about 1 - roughly same positive and negative.
For 35% winning, the ratio is about 2 - the scale has tipped in our favor, but not enough.
For 40% winning, the ratio is about 5 - strong enough for profitability.

By improving just 7% over random trading, one has become profitable. The edges in trading are small, and any 'tiny' improvement has large impact.

Suppose we bat 45%.

Case 4: 45% Winning (Expert)

If we can bat 45% at 1:2, we are not merely profitable. One has become an expert. This step is likely to take a long time.

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For 45% winning, the ratio is about 7 - expertise combined with experience.

Note that for the first time, none of 10000 trails ended below the start point. The edge is huge and the chance of ending up a loser is less than 0.01%.

But some traders evolve even further, to master status.

Case 5: 50% Winning(Master)

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If one can reach 50% winning rate at 1:2, one is indeed a master.

For 50% winning, the ratio is about 15 - absolute mastery of mind, method, and money, combined with experience.

However, there is another level.... this level is called LIAR.

Case 6: 60% Winning (Liar)

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For 60% winning at 1:2, the ratio is about 39 - absolute mastery of mind, method, and money, combined with experience. I AM THE MARKET. Monstrous edge of a trading mystic.

I'm not sure 60% at 1:2 RR is attainable... but you never know. Until I see somebody's trading records, I'm calling this the LIAR level (if you exist, speak up!).

Summary

This brief study is not meant as a 'proof', but rather a demonstration of the fact that the difference between success and failure in trading is a single digit percentage. The edges in trading are small, and even tiny improvements make a large difference, especially over extended periods of time.
Tracking one's percentages and using a trading trial simulation can be a valuable tool in determining process goals and orienting oneself on the ladder of success.

Happy Trading!

PS Thanks to @Big Mike for making this forum possible.

"...the degree to which you think you know, assume you know, or in any way need to know what is going to happen next, is equal to the degree to which you will fail as a trader." - Mark Douglas
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  #3 (permalink)
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Interesting analysis. From my own testing I've found that edges become relatively stronger the higher the timeframe (and holding time) of the trade. The more often you trade, the greater the vig and the more difficult it is to obtain an edge. So why trade short-term?

Undercapitalized
Bored



But also you learn a heck of a lot faster and you can execute a smaller edge over many more trades. Which smooths your equity curve substantially.


Last edited by eudamonia; May 2nd, 2012 at 07:46 PM. Reason: clarification
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eudamonia View Post
Interesting analysis. From my own testing I've found that edges become relatively stronger the higher the timeframe (and holding time) of the trade.

I have found that statement to be quite true. Get above the traders into swings or higher, and you can find and hone better edges. I wore myself out trying to find edges at the lower time frames, yet all my results points towards taking longer term trades at a minimum being willing to hold overnight. ~4 days is now my holding period.

Pic is of bot results "In Testing Sample" and "Out of Testing Sample". Obviously there are not as many trades out of sample yet, but looking at the numbers I would consider them statistically equivalent even though I have not actually done a stat test. The Out of Sample is a back-test, but I assure you that the results are equivalent in live trading. Just thought it might give you some additional real data for testing.

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Why is it you think a 60% win rate would mean you are a liar, exactly?

I think you have crunched some interesting numbers but to conclude someone with a 60% win rate is a liar is a stretch IMO.

The 1:2 r:r is also somewhat misleading in my opinion because in my experience, traders don't necessarily set and forget arbitrary targets. Trades need to be managed, not left with a hard risk:reward ratio.

I regularly open trades with a 4 tick stop on the ES. It is not unusual for me to get 6+ points on my last portion. That doesn't mean I have a 1:6 R:R. It means I scale out & manage the trade. Same on the downside I might get out at -1 tick, usually when market moves against me but comes back to give me a better exit.

What would be interesting would be to see the impact of better trade management. Not sure how that would be done.

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eudamonia View Post
Interesting analysis. From my own testing I've found that edges become relatively stronger the higher the timeframe (and holding time) of the trade. The more often you trade, the greater the vig and the more difficult it is to obtain an edge. So why trade short-term?

Undercapitalized
Bored



But also you learn a heck of a lot faster and you can execute a smaller edge over many more trades. Which smooths your equity curve substantially.

At 1:2 RR, 40% winning rate overcomes vig (that's not to say that vig isn't important. It is.)

Yes, edges are stronger on higher timeframe, but there's much less opportunity.

Suppose one goes from trading 5 min charts to daily charts. You have just reduced your opportunity by a factor of 81!! (There's 81 bars every day on 5 min chart).

"...the degree to which you think you know, assume you know, or in any way need to know what is going to happen next, is equal to the degree to which you will fail as a trader." - Mark Douglas
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DionysusToast View Post
Why is it you think a 60% win rate would mean you are a liar, exactly?

I think you have crunched some interesting numbers but to conclude someone with a 60% win rate is a liar is a stretch IMO.

The 1:2 r:r is also somewhat misleading in my opinion because in my experience, traders don't necessarily set and forget arbitrary targets. Trades need to be managed, not left with a hard risk:reward ratio.

I regularly open trades with a 4 tick stop on the ES. It is not unusual for me to get 6+ points on my last portion. That doesn't mean I have a 1:6 R:R. It means I scale out & manage the trade. Same on the downside I might get out at -1 tick, usually when market moves against me but comes back to give me a better exit.

What would be interesting would be to see the impact of better trade management. Not sure how that would be done.

Spot on!!

Simple R:R calculations are just one piece of the story. Trade /money management has to included to justify any potential stategy.

Since there were 4 consecutive losses ,why no set them up at the beginning of the exercise and see what kind of drawdown it would be? How often were there 4 consecutive losses.?

In real time, how would the "5th" trade be handled?

Trader

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Live Your Bliss
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DionysusToast View Post
Why is it you think a 60% win rate would mean you are a liar, exactly?

Because it gives one a monstrous edge... and such edges do not exist in the market, in my experience... at least not for long stretches of time.


DionysusToast View Post
The 1:2 r:r is also somewhat misleading in my opinion because in my experience, traders don't necessarily set and forget arbitrary targets.

Actually, 1:2 is far from arbitrary. It's a commonly used ratio as indicated by frequent profit taking pullbacks at that level (as is at 1:1).

"...the degree to which you think you know, assume you know, or in any way need to know what is going to happen next, is equal to the degree to which you will fail as a trader." - Mark Douglas
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Family Trader View Post
Simple R:R calculations are just one piece of the story. Trade /money management has to included to justify any potential stategy.

You seem to have missed the point of the thread.

"...the degree to which you think you know, assume you know, or in any way need to know what is going to happen next, is equal to the degree to which you will fail as a trader." - Mark Douglas
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Anagami View Post
Because it gives one a monstrous edge... and such edges do not exist in the market, in my experience... at least not for long stretches of time.



Actually, 1:2 is far from arbitrary. It's a commonly used ratio as indicated by frequent profit taking pullbacks at that level (as is at 1:1).

60% with a 1:2 RR is a very nice edge I would not call it monstrous. It is doable for long stretches of time.

"The day I became a winning trader was the day it became boring. Daily losses no longer bother me and daily wins no longer excited me. Took years of pain and busting a few accounts before finally got my mind right. I survived the darkness within and now just chillax and let my black box do the work."
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