Every trader wants to learn how to trade more profitably. But could our very desire for winning be the biggest obstacle to us making money?
One thing that I thought would be interesting to share with you is a recent study I read on the behaviour of experienced vs inexperienced traders, particularly in relation to what they focus on.
Before I go any further, have a think about your trading and what you pay attention to in terms of your results.
Is strike rate the most important thing?
Are you only attracted by systems that claim an 80% strike rate?
Is making a winning trade more important to you than the size of your winning trades?
If you have answered yes to any of these questions, then you could be in danger of making a common beginner mistake. You might be motivated more by being right than making money. It’s not all about winning.
How to trade: new research revealed
CXO Advisory recently posted a summary of a study which looked at the behaviour of stock market traders.
They found that the win-loss percentage of recent trades was significantly more import than bottom line profitability. I.e. traders focused more on winning a trade than making money overall.
Each trade you make will either make or lose you money, this will determine the strike rate. This much is easy enough to understand, but it’s only half the story. How much do those winning trades make versus how much do those losing trades lose?
You can have a system with a strike rate of 90% and still lose money if the occasional losing trade wipes out the winning trades. I see this quite often with all the betting bots that come on the market. It’s common to see lots of winners in the region of 10 points, but then a few massive losers of perhaps -100 points.
Why do they do this?
It’s perhaps a clever ploy, because they know what beginner traders focus on more – The strike rate. So if you give them systems that win on a high frequency basis, they are more likely to be happy, even if they lose money overall.
Specifically, the CXO study found that:
The win/ loss percentage of the last 5 trades was most important – i.e. very short term thinking. The relative importance of the strike rate declines as traders become more experienced – i.e. as people trade more, they become more patient and focus more on the bottom line.
There are some important lessons than can be taken away from this.
When you are trying out a new system don’t be swayed by the strike rate alone. It’s the bottom line that is most important.
When examining your trading or a system make sure you
look at:
1. The strike rate.
2. The average winner divided by the average loser.
3. The average return per trade.
4. Your bottom line profits.
The fact is that financial markets have a lot of randomness and maintaining a high strike rate in the long run is only possibly by having a low risk reward ratio (i.e. small profit targets and large stop losses).
Systems with low strike rates, but with big winners to compensate often have better returns in the long run. The trouble is that it can be hard to learn to cope with losing runs in the early days.
With the apprentice back on TV, it might be useful to draw an analogy from that.
In the group tasks, the teams can often choose to sell low value items or high value items. Last year they could choose between selling experience days for super cars costing a reasonable amount, super super cars costing a little more or selling top of the ranger super super super cars that cost a mint to experience, even just for an hour.
Low cost cars requires high volume of sales (high strike rate).
High cost cars requires low volume of sales (low strike rate).
The trade off is that you might need to sell 25 low range experience days to make the same amount of money that you would from selling one top of the range experience day. The risk is that you will not be able to sell too many of these (especially now those city boys have less cash to play with!).
You can make money with any method, but it’s interesting to note that the teams that plump for the big winner, low strike rate sales method often win in the end.
The clothing retailers are also a good example of these at the moment. They’ve slashed their prices to keep orders coming in, but at the same time this has reduced their margins. It would be wrong to focus on sales alone in this environment (i.e. strike rate), without taking into account the lower profit made on each sale.
There is the trading maxim of letting winners run and cutting losers quickly. The problem is that this can decrease your strike rate. Often, it’s psychologically more appealing to grab quick profits on each trade. This can sometimes be the worse thing you can do in terms of your overall profitability.
I hope this helps your trading and most importantly, your bottom line!
