I hope you had a great bank holiday and managed to catch some of the elusive sunshine. It was a warm one in the artificial heat bubble that is London and I enjoyed some much needed off time in the park with some friends and a frisbee.
My trading affliction got the better of my points yesterday and I couldn’t help a quick look at my charts and emails.
I’ve received a lot of emails about UFXP. I’m still impressed by what I’m seeing and with how easy it is to use. I’m much preferring the trading method rather than the scalping method because I think you’ll get better returns after the spread in the long run. It’s a lower strike rate, but the gains are bigger when you do let one ride. That’s just my preference, I have heard from others who are enjoying the quick scalps.
This got me thinking about one of the things that used to confuse me when I first started trading, namely, how could you lose money with a high strike rate?
When I first started out I was obsessed with finding something that worked 100% of the time, something that would make me money with every single trade: I was trading to win. Therefore, I was drawn in to systems that promised: “90% strike rate”; “win on every trade”.
Needless to say, they all lost me money, but how can that be? Surely, with a strike rate of 75%+ you can’t lose money?
Wrong.
Why a high strike rate and trading to win needs to be put into its correct context
A system’s strike rate needs to be put in the context of its win to loss ratio. A win to loss ratio is the size of the average gain compared to the size of the average loss.
What does this mean?
This means that just looking at a system’s strike rate is like deciding to buy a car based on its maximum speed alone and ignoring its handling, reliability, safety or petrol consumption. Even petrol-head Jeremy Clarkson at least grudgingly concedes every now and then that there’s more to a car than raw power.
I sometimes get emails saying:
“It’s amazing, a 75% strike rate so far”;
“It’s terrible, I lose half my trades”;
“I’ve only won around 1 in every 3 trades”;
None of these statements alone make something a good or bad system.
Here’s why….
If a system has a 50% strike rate, your system has to have a win to loss ratio of greater than 1.0. This means that if your average loss is the same size as your average gain you will break even (E.g. you are risking 10 pips to make 10 pips), but if your average gain is slightly bigger than your average loss then you will make a slight profit (e.g. risking 10 pips to make 15 pips). This ignores the impact of any spread. If your system just wins half the time, but the average gain is three times the average loss (e.g. risking 10 pips to make 30 pips), you will make money in the long run.
If a system has a 75% strike rate, you will have to have a win to loss ratio of greater than 0.25. This means that you can afford to have the size of your average gain to actually be less than your average loss. For example, you might be able to get away with risking 10 pips in order to win 8 only because your strike rate is so high. Obviously, you’d prefer your average gain to be greater than this, but it is rare that a high strike rate system has an average gain that dramatically outstrips the average loss. Such systems are like gold dust.
What about that system that is claiming a strike rate of 80%, surely that will make money right?
Not necessarily. What if it won lots of the time, but when it lost, it lost huge? Again this isn’t necessarily a bad thing if the occasional loss doesn’t completely obliterate your profits in the long run. The guys at City Beaters make good profits with such a method. However, it could be a bad thing if your average loss was 50 times your average gain. Then you’d be in trouble!
This could be the case if you were selling options without hedging – your gains would be limited, but your losses would be unlimited!
Finally, what about the system that only has a strike rate of 30%?
This actually could still be incredibly profitable if the average gain was huge compared to the average loss. For example, you might make lots of losses of around 10 points, but you could be exposing yourself to gains of 200 points or more.
In the long run, systems with 30%, 50% and 75% strike rates could end up making the same amount of money depending on their average win loss ratio. The difference of course is the mental requirements of each system – i.e. patience.
A low strike rate / high average gain system requires patience and full confidence in the system you are using. Often these sort of systems make more money in the long run because the lower number of trades means that the spread or commission eats into your returns less.
A high strike rate/ low gains system might suit someone with less patience, who wants to feel the winners often even if it means missing out on the occasional monster gain.
The success of you using a system may be no reflection on your trading ability, but on the degree of fit between the system and your personality. I’ve tried hundreds of systems and spoken to dozens of traders and the same thing keeps cropping up, the system has to suit you.
I hope this helps you find a strategy to suit your style whether you’re a scalper or a patient low strike rate trade.
My trades
I’ve made numerous intraday trades on Forex using UFXP resulting in an overall gain of over 100 pips. Had I pulled my finger out this week I could have made 259 pips if I’d have taken all the trades I saw. As it stands I have made just over 100 pips mainly thanks to one great trade which netted 131 points. I was about to go for my lunch time run, when spotted it, I’m glad I didn’t. More details here: UFXP
I’ve also been trialling one of the systems I mentioned ages ago from Collective2 which if you remember was amarket place for systems with results recorded and proofed. I’ve found the best one was the less than elegant sounding Topaz NQ 100M, not a great name, but the trades seem remarkably consistent. It’s a high strike rate/ low average gain type system which has been making around 4% a month.
I went short one contract of the emini S&P500 yesterday. Testing the water on this one really. The VIX Options Volatility Index, a good measure of market fear and complacency, now stands at levels not seen since late December 2007. Around the time that the Dow Jones fell nearly 2000 points in less than a month. While another 2000 point drop may not be in the offing, I think there are growing indications of complacency in this rally.
This week’s top trading buttons
After the deluge of data that hit last week, the forthcoming week is at least reduced in its intensity. The stand out announcements come on Thursday from a European perspective with the Bank of England announcing their latest interest rate decision. Analysts are expecting the MPC to keep rates on hold as they balance the twin terrors of inflation and an economic slow down. The ECB are also holding a press -conference an hour and a half after the MPC announcement and are also expected to keep rates on hold for a while.
Trading wisdom
“Nobody should be puzzled as to whether a market is a bull or bear market after it fairly starts. The trend is evident to a man who has an open mind and reasonably clear sight, for it is never wise for a speculator to fit his facts to his theories.” – Jesse Livermore.
