Hello traders! This week I’d like to talk about a topic that comes up in every Online Trading Academy class that I teach – that is the topic of your win/loss ratio. Most new traders (and many experienced ones!) believe that a very high win/loss ratio is necessary to be a profitable trader. This is very far from the truth.
First let’s define what a win/loss ratio is. Investopedia defines the win/loss ratio as: “A ratio of the total number of winning trades to the number of losing trades.”
It does not take into account how much was won or lost, simply if they were winners or losers.
If you make ten trades and have six winners and four losses, your win/loss ratio is 6:4 or 3:2, or even 60%. Many new traders think this number is too low! Why do they think that? In my opinion one of the primary factors that make people think this number is too low is that they compare it to the same grading scale that they have had in their regular education experience. In the schools that I grew up in, if you only scored 60% you were a “D” student, bordering on failing. For those of you who aren’t familiar with our basic grading schedule, scoring between 90% and 100% is an A, 80-89% is a B, 70-79% is a C, 60-69% a D, and below 60% is an F or failing grade. Too many new traders are looking at this win/loss ratio and comparing it to their grades in school! This is understandable, as most of us spent most of our formative years being graded in this way – from fifth grade or so (about age 10) to high school graduation (about age 18) to college, through grad school, etc. This deeply rooted and long-held belief will cause many new traders to become discouraged when their trading performance doesn’t equate to getting a good grade in school. How many jobs out there can you be wrong 50-60% of the time and still keep your job? Weatherman? Politician? The point is this: you have been “programmed” for years if not decades to believe that attaining 70-80-90 percent or higher is necessary to be a success. This is far from the truth in trading.
When speaking to more experienced traders, including other instructors, many tell me that their win/loss ratio is around 50% or even below. Oh no, they must be a failing student or a bad trader! This is far from the truth. When focusing on the win/loss ratio only, you are missing the very important component of your average wins vs. your average losses. If your average wins (gains) are 20 pips and your average loss is 20 pips, you must have a win/loss ratio of well over 50% to make any real money in trading. In our classes we recommend that traders look for trades that offer at least a 3:1 reward to risk ratio. The two main reasons for this is that you will search for higher quality trades, plus you don’t have to have a very high win/loss ratio to make actual money in trading. With a 50% ratio and average winners of 30 and average losses of 10, out of ten trades you would have gained 150 pips and lost 50, giving you a net of 100 pips. Not too bad!
The sooner you can get to the point of realizing that the win/loss ratio isn’t the most important thing in trading the better off you will be. Occasionally I will read a book or an article about trading written by some legendary trader out there (thanks Alex P. for loaning me the last one!). Most of the time these books refer to their win/loss ratio as a mere afterthought – many are so “concerned” about taking large losses that they manage their trades very, very closely. So closely that they may take just a few pips or ticks of a loss, but these traders are very good at letting their winners run. Taking nine small losses of ten pips, but having ONE big winner of 100 or more makes you a profitable trader. It all comes down to letting your winners run which was covered in several previous newsletters. These traders may have a win/loss ratio of 1:9! This ratio might be difficult for new traders, so finding the happy balance that works for your psychology is of utmost importance.
In the future, actively manage those trades going against you and letting your winners run will eventually show you large profits! Practice managing your winners, and you too could be as right as a weatherman and still be a profitable trader.