I'll get right to it...this post from Bill Poulos from Profits Run is excellent! We've all been in this situation, where we look for a great methodology for our trading style, look at published winning percentages, and then cry when it completely blows up your account...yes we've ALL been there! In Bill's new article he helps you figure out the solutions. Bill's expertise really comes through in this article and he's just released his “Risk Eraser” technique video so check it out today!
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While doing research on the current state of the Forex trading landscape, I discovered something surprising.
Losing Forex traders appear to be enamored with 'winning percentages' when selecting a forex trading method.
The irony in that statement should be obvious -- if the 'winning percentage' of the forex method is so important, how can these traders still be net losers?
Because, I believe, winning percentage is the wrong concept to focus on. In fact, I find winning forex traders look for methods that have winning percentages closer to 50-60%. And, they also have one more 'secret' that losing traders DON'T have.
The difference will probably surprise you - and it's a big difference, too. The answer should have been obvious, but it isn't for most traders.
Ask yourself this question: How is it possible that a forex trading method that wins 80% or more of the time can end up a net loser?
The answer?
Losing trades. BIG losing trades. Here's what I've discoveredmany of those methods (or robots) that claim 85% or 97.7% winning trades aren't telling forex traders:
When their systems 'win', they are making a lot of very small gains.
But when their systems 'lose'? They wipe out all of the gains and a good percentage of the trader's account balance, too.
Still, traders flock to these methods because, after all, something winning 'almost' 100% of the time must be good, right? Not really, no.
See, what most traders don't get is that the reward to risk ratio in those high win percentage methods is upside down. Traders are risking way too much capital for way too little profit potential.
That's poor risk management and can easily lead to one becoming a 'losing' trader.
Let me illustrate an example, using a 'typical' Robot trader, making 5 trades:
Trade 1 - gains 8 pips on 20 mini lots (+ $160)
Trade 2 - gains 8 pips on 20 mini lots (+ $160)
Trade 3 - gains 8 pips on 20 mini lots (+ $160)
Trade 4 - loses 80 pips on 20 mini lots (- $1,600)
Trade 5 - gains 8 pips on 20 mini lots (+ $160)
This is standard practice for automated systems/methods out there that don't employ smart risk management. They set stop losses that are far too wide given the reward ratio. Here it's 10:1 (risking $10 to win $1 - does that make sense?)
Say you had a starting account balance of $10,000 -- at the conclusion of these 5 trades, your account balance would be $9,040.
That's a 9.6% loss even though you 'won' 80% of your trades!
We haven't factored in lot or position size yet, either. I would expect it to be a given that the trader above is taking on far too much risk. Keep in mind, too, that trading with an automated or robot method, you are unlikely to be able to stop that 80 pip loss unless you happen to be watching it unfold.
Of course, that robot is supposed to make you money 'while you sleep' - isn't it?
The bottom line is if you aren't managing risk in every single trade, from determining the correct lot and position size to the right points for your stop losses and your exit strategies, you will NEVER join the elite 5% of successful Forex traders.
Let's illustrate a 'winning' trader using a Forex trading method (not a robot), who only wins on 60% of their trades, and see if you note right away what their 'secret' is:
Trade 1 - gains 43 pips on 10 mini lots (+ $430)
Trade 2 - loses 30 pips on 10 mini lots (- $300)
Trade 3 - gains 29 pips on 10 mini lots (+ $290)
Trade 4 - gains 19 pips on 10 mini lots (+ $190)
Trade 5 - gains zero pips on 10 mini lots (+$0)
Again with a starting account balance of $10,000 -- this trader would have made a 6.1% gain ($610 net), as opposed to the first trader's nearly 10% loss.
Yet, this trader only 'won' 60% of the time? What happened?
This trader 'broke even' on 1 of the 5 trades. No gain. No loss.
What the 'winning' trader does is eliminate risk as quickly as possible, thereby ensuring infinite reward (until they liquidate their position). To do this, these traders take aggressive action to move their initial stop losses up to the break even point from the outset of a trade, set an initial profit target and, once they are able to eliminate the risk side in the trade, they will manage the profit side of the trade by scaling out in stages at predetermined profit points.
In this way, once the trader has been able to 'erase' the risk side, they can focus solely on the profit side - with the worst case scenario being a 'zero' gain trade (or, break even).
Now you may not be able to eliminate risk in every single trade; but breaking even on just 1 in every 5 trades can have a significant and positive impact on your account balance.
So, don't let yourself be fixated on the 'winning' percentage of a trading method. As you've just seen, that doesn't guarantee you can be a net winner. Instead, put risk first and profit second. I think you'll be surprised at the results.
Good Trading,
Bill Poulos
For more examples of how to eliminate risk in your Forex trades, I invite you to watch a recent video series Bill did on 'erasing risk'.
See the training videos here “Risk Eraser” technique video
The media associated with trading is also largely to blame for the unrealistic expectations many traders seem to have about perceived gains from trading. Unfortunately the truth is that anything in life that yields great reward comes with a commensurate amount of risk with a huge effort. Always beware of anything that purports to enable easy, effortless profits such as the "forex robots" or the "internet marketing" or trading or whatever. The inverse would be the "winning the lottery" attempt where there is little perceived risk "it's only a dollar" but the reality is it is 100% risk with no probability of winning anything.
Truly a losing proposition.
The point is that learning to trade with consistent winning results is going to be the hardest thing anyone has ever done. The reason is that it involves learning total self-control and most people do not have what it takes to achieve that.
The marketing behind "robots" is something else. Web is just loaded with them, much more than any previous "wonder" systems. An average new comer can easily be overtaken by the hype.
Very good point that becoming consistent trader is not easy. It takes patience and discipline, over time. It can be simple, but not easy.
You need to know % of winners, how much each winner makes and how much each loser makes. This needs to then be translated to probabilities of losing / winning runs. This leads you to what your maximum drawdown will likely be.
Personally I am happy with lots of small losers with a smaller number of large wins, but prefer 50-60% winners with slightly larger winners to losers. This makes the drawdown easier and the losing streaks easier to bear.
However, key to success with any method is to back test and forward test your method and assess these figures yourself. Then YOU know what your expectations can reasonably be and can plan your trading accordingly. eg, if you win/loss ration is one figure you can then work out the probability of different sized losing runs and when they happen you will not be too surprised and give up.
Unrealistic expectations i what kills most small traders. They have a few huundred or thousand dollars and expect to spend five minutes a day trading to provide a luxurious income while they sit on the beach most of the daty. Aint gonna happen.
Trading success is about 15% the methodology (or system or whatever) and 85% the trader's self control. That is the secret. An example of haow a "small" trader could manage risk with a small account is to base the risk of a trade on a faster time frame for an objective on a longer time frame. Another aspect of risk control (which Mark Douglas aptly delves into) is the concept of REALLY ACCEPTING THE RISK on a trade. I have found this is enhanced greatly by trading price action tests instead of breakouts. This is best done by interfacing time frames to build in a favorable risk / reward as the structure of the trade. With an awareness of the fact that any given bar has a probability of making some range associated with it. These probabilities are very very important. Say for instance a trader is going to put on a trade on the russell mini and the 15m bar that finishes at 0900 has 5.7 points on it and the time is 0855. Well the 3-bar range might be 2.35 points and the 10-bar range might be 2.9 points. So is there a good probability of making any appreciable gains on this trade since this current 15m bar already has double the normal range on it and is 2/3rds finished time-wise? It could, BUT the most probable equity available on this trade is already past! This would be trading the long-tail distribution on the downhill side...not a very good recipe for cooking up a batch of winning trades.
What I am getting at is using probabilities to enhance a trader's risk-acceptance ability. Also helps to prevent overtrading and simulates trading the way the "big" traders do it. Put your winning percentage in line with the probabilities and confidence with consistency is enabled.
Good article, thank you... Everybody talks about reward and only the serious and successful traders think about risk. Everybody wants to make money trading but few spend the time and effort to build a strong base on their money and trade management rules to manage the risk side of the equation. The most important ratios I believe in trading are the win/loss ratio, the risk/reward ratio and overall expectancy ratio (see Van Tharp's "trade your way to financial freedom" book). These tell you tons more about your trading system than a mere win percentage - Great article, and again thanks for pointing this crucial element out
Arbitrarily moving stops around to "Eliminate Risk" sounds risky. Maybe it sounds good when your retail trading experience has you running and confused as to what will happen next. The truth is,, "It is too good to be true!!" The floor traders are hunting for underfunded retail traders with tight stops already. I have moved stops to be stopped out and then see the expansion run 80 points after I'm out. They hunted me and Killed me. Got hammered. Sometimes lucky, but mostly Hammered.
You have sold me "NOT" to buy any Robots!!! Thank you.
I'm a Loser and Proud of it.
(Visit url above)
A Mark Douglas quote from “The Disciplined Trader”:
Most people like to think of themselves as risk takers, but what they really want is a guaranteed outcome with a little bit of suspense.
It’s always astonished me how much time people spend trying to eliminate risk. It’s irrational. We all know this is impossible. Instead, one needs to quantify the risk and then change their mindset so that they truly learn to accept the risk. This may be the risk of losing money, the risk of being wrong which can lead to criticism from colleagues or clients, or the risk of missing moves by either entering late or exiting early which could lead to a different type of angst all together. Only when we can truly accept all the risks involved in trading, we will become better traders.
It happens to me all the time, is nice video about it and i'm trying
to practice and still have loosing trades.
It is very true, perecntage of winning trades ia not everything. Total result, as expressesed in net account gain, over time is more important.
However, given two different strategies, both of them being profitable, majority of people will likely choose one that has more winners. From psychological view, most of us want to be right more often than wrong. Never mind that in this scenario an average loosing trade will be bigger.
Traders have to decide for themselves if they want more smaller losses or fewer bigger once. Of course, a winning strategy must be in place first in order to make money at all.
Why not always move your stop and always let the market knock you out? Let profits ride.