Which do you prefer – a strategy which gives you a high win-rate or one which gives you higher profitability?
The answer, of course, is “it depends”.
It really depends on what kind of win-rate we’re talking about and what kind of profitability we’re talking about.
Personally, I would rather a high win-rate. Definitely one that is higher than 50%.
In fact, I ideally would want something that is at least 60% or higher.
I would rather a strategy which gives say a 60% win-rate and an overall 30% gain on account after 100 trades, as compared to a strategy which gives a 40% win-rate and an overall 50% gain on account after 100 trades.
It’s just me.
I don’t like experiencing more losing trades than winning trades.
It’s a mental and emotional thing.
I suppose some traders can accept a less-than-50% win-rate.
But I know myself pretty well. I don’t like to lose more than I win, even if the overall profitability may be higher for a lower win-rate.
There are two main reasons for this:
More losing trades leads to emotional vulnerability, and you need to have a really strong mental game to be able to withstand a 40% win-rate.
Emotional vulnerability may lead to revenge trading (i.e. taking ill-advised trades which leads to even more losses).
Just learnt an important lesson recently, after going through a day of higher than expected losses.
The lesson is: Create an extremely stringent set of rules so that it completely filters out any discretion whatsoever.
Because if your strategy rules aren’t stringent enough, after some losses you may end up wanting to take more and more trades just to “get back” at your initial losses, and these trades may be ill-advised ones.
And it makes you even more upset when you lose even more.
This is just my own experience.
I personally feel it would be better for me to have multiple stringent rules and indicators so that I don’t take bad trades and start getting upset and want to trade more.
To be more specific, in my case here I’m talking about using multiple indicators to make absolutely sure that I’m in a legit trend (and not in consolidation) before taking a trade.
Backtesting your strategy is essential before attempting any form of live trading.
I personally do not think that a simple backtest of 50-100 trades will give an accurate portrayal of your actual live trading results, simply because i) the sample size is too small, and ii) market conditions change all the time.
However, there are still some benefits to backtesting, in my opinion:
It gives you an idea of whether your strategy is a profitable one or not. Let’s put it this way: If your backtest yields unprofitable results, you can be sure it will not be profitable in live trading. If your backtest yields profitable results, then there is a chance it may still be profitable in live trading after factoring in spreads and provided there is a solid risk management plan.
It gives you some kind of assurance and emotional support when you start hitting a bad patch in live trading. No doubt, a backtest sample data of 50-100 trades (or even 200 trades) is hardly conclusive, but it at least serves as a rough chunk of data to rely on, and you would know your approximate projected win-rate, profit factor, and number of consecutive wins and losses. So at least when you hit a string of losses, you can still find the motivation to stick with the strategy and not abandon ship immediately.
Besides, let’s face it – there can never be a thing as enough backtesting.
What is enough backtesting? 100 trades? 1,000 trades? 10,000 trades? Or all trades since the beginning of time?
And even if you manage to backtest every single trade since the beginning of time, some traders would still tell you that that doesn’t guarantee anything because markets change all the time.
So who really knows right? You just have to go with whatever backtest data you’re comfortable with.
Pursuant to my last post below on exit strategies, I stumbled on this YouTube video which I thought was rather insightful.
For some reason, very few people discuss the finer details of exit strategies, e.g. setting multiple take-profit targets, taking partial profits, moving stop-losses to breakeven, letting trades run etc.
Most people seem to only focus on ideal trade entry conditions.
Hence, I found this video really insightful because he actually shows some calculations on the different partial take-profit scenarios, such as what happens if your first take-profit is 50%/60%/70%/80%/90% of your position, and what the eventual overall net profit from those different trades will be.
Very useful to know.
But ultimately I’m just glad to see that there is at least someone on YouTube who is highly interested in going much deeper into the finer mechanics of trade exit strategies, because I myself had also been spending the past few weeks thinking hard about this subject.
Of course, in an exercise like this there will always have to be certain assumptions that you are maintaining a fixed win-rate (say 40%) and risk-reward ratio (say 1:3).
Personally, at this point in time, I’m beginning to lean more towards the following trade management rules for my own style of trading:
Take-Profit 1: Take 50% profits at 1.0x risk, and move stop-loss to breakeven.
Take-Profit 2: Take the remaining 50% profits at 2.0x risk.
Assume my position size (or risk) is $100, and assume no commissions in this case:
If price moves to my first TP target (i.e. 1.0x risk), then my minimum profit for this trade would be $50.
That means that even in the worst possible scenario thereafter, I will not make any less than $50 on the trade since it has already been cashed out (and because I had also moved my stop-loss to breakeven at the first TP target).
If price moves to my second TP target (i.e. 2.0x risk), then I would have made my maximum possible profit for this trade, which is $150 in total (i.e. $50 at first TP, $100 at second TP).
The are tons of YouTube videos about the best entry signals for day trading.
However, I feel there is a relative lack of discussion with regards to exit signals.
Which is ironic, because someone once said that the exit strategy is far more important than the entry strategy, and I think that is absolutely true.
You don’t make a single cent from an entry strategy. The exit strategy is where your money is made.
Every exit strategy has its own pros and cons.
Let me try to summarize:
EXIT STRATEGY 1: “SET AND FORGET”
Description: Set a fixed stop-loss (e.g. 1x ATR) and take-profit target (e.g. 2x ATR) and don’t do anything else.
Easy to manage. In fact, no management required at all.
Won’t get stopped-out prematurely (as compared to moving up your stop-loss midway through the trade).
Potentially frustrating if price comes very close to hitting your profit-target but then it goes all the way down and you end up losing the trade instead.
Determining the optimum take-profit target is tricky. Is it 1.5x? Or 2x? Or 2.5x? A lot of backtesting is required to determine this.
EXIT STRATEGY 2: USING EXIT INDICATORS
Description: There are numerous indicators which can be used as an exit indicator, such as moving average lines, MACD, Parabolic SAR, Heikin Ashi bars, SSL Hybrid, Aroon, etc.
Straightforward. No ambiguity.
Occasionally you may catch really huge moves.
In my experience, you usually leave significant profits on the table, which can be frustrating. For example, your trade may have gone to 4x profit, but the exit indicator only gives the signal when it comes back down to 2x profit. Also, if the move is a small one, you may actually end up with no profit or even a small loss. Some people may not be able to take this.
EXIT STRATEGY 3: USING A TRAILING STOP-LOSS
Description: This method means you don’t set a profit-target at all. You just let the trailing stop-loss trail price all the way until it comes back down and triggers the trailing stop-loss.
Easy to implement. No management required. Just let the trailing stop-loss do all the work for you.
You may catch really big moves.
Determining the optimum trailing stop-loss value is a tricky problem. Too big, and you may end up with no profits if the move is a small one. Too small, and the trailing stop-loss may get triggered easily.
Similarly with using exit indicators, you may end up with no profit or even a small loss if the move is a small one.
EXIT STRATEGY 4: TAKING PARTIAL PROFITS
Description: Take off partial profits in tiers when price reaches specific checkpoints, e.g. cash out 25% when it hits 1x profit, cash out 25% when it hits 1.5x profit, and cash out all the remainder when it hits 2x profit.
You are wisely putting some money in your pocket as your trade becomes more and more profitable.
Psychologically comforting. You know that even if the trade suddenly goes south, you already have some profits safely cashed out. You will be more willing to let the trade run until it hits your desired take-profit target.
Tedious to manage, especially if you have multiple trades going on simultaneously.
You will collect less profits as compared to if you had waited till the final take-profit target to cash out 100%. For example, if you had a profit-target of 2x, you will collect more profits by cashing out 100% of your position at 2x, as compared to taking partial profits along the way.
Apart from the 4 strategies above, you could even do a hybrid strategy where you take partial profits in tiers, and then let the remainder trail with either an exit indicator or a trailing stop-loss.
I’ve spent countless hours pondering over what the best exit strategy for a trade is.
And the conclusion I’ve reached is that there is no one perfect exit strategy.
It depends on factors such as your personality, the style of trading you prefer, your risk appetite, the volatility and nature of the instrument you trade, etc.
If you’re the kind that likes to make your profits slowly, surely and steadily, then maybe Exit Strategy 4 might be best suited for you.
Personally, I don’t really like Exit Strategy 2 and 3 because I just don’t like seeing that I’ve only made 1x profit on a trade that had gone as high as 3x at one point. It just doesn’t sit well with me.
As such, at this point in my trading, and after trying out so many different types of exit strategies, I’m leaning towards Exit Strategy 1 (“Set and Forget”) because despite its simplicity, I actually find it’s one of the most suitable methods for me.
But of course, before you decide to adopt any kind of exit strategy, make sure you do a lot of backtesting first.
I enjoy watching Spencer Cornelia’s channel. He specialises in exposing a lot of fake gurus and scam artists, and he’s really good at it.
This particular video above is a bit different though. He tracked down a legit professional sports betting outfit based in Denver, Colorado and talked to them in-depth about how they run their operations.
I particularly liked this part (timestamped above) where this guy Dave from that Denver outfit talks about their edge.
So Spencer asks him: “Do you have a specific number that you know, over enough bets, you’re gonna be up (say) 4% on the dollar?”
To which Dave confidently says “Yeah”.
Dave then goes on to explain in detail about his edge, and it is very clear that Dave understands that as long as he has a significant edge, in the long run, after placing a high number of bets, he will end up profitable.
In this respect, I think professional sports betting is no different from professional day trading.
You can’t be successful in sports betting if you don’t know your edge, or your expected value (EV).
Similarly, I believe that if you want to be a full-time day trader, you can’t possibly not know your EV per trade for your strategy.
It’s like going into an MMA fight against a professional MMA fighter and not knowing where your strengths lie, in which ways you have an advantage over him, and what your exact gameplan is going to be in order to defeat him.
To know your EV in trading, you basically need to know these four things:
Your expected win percentage
Your expected loss percentage
Your expected dollar profit per winning trade
Your expected dollar loss per losing trade
For example, if you expect to win 70% of your trades and lose 30% of them, and if each win is expected to give you $150 profit and each loss is expected to lose you $100, then your EV per trade would be:
(70% x $150) – (30% x $100) = $75
So once your EV is established – assuming it has been well-validated using backtest data – you can then confidently know that as long as you keep trading using this exact same edge, over a large enough number of trades you will become profitable in the long run, at an approximate rate of $75 profit per trade.
It may take 100, 1,000 or even 10,000 trades to get very close to this figure of $75 profit per trade, but over the long run, the law of large numbers will ensure that you get closer and closer to the theoretical EV of $75 profit per trade.
Of course, the important thing also is to not waver from your strategy, and not lose hope when you hit a run of losing trades.
It’s all math and probability. Theoretically, as long as you do it enough times, you will achieve your EV.
The biggest challenge is in:
Not blowing your account due to a series of losses.
Not losing heart and wavering from your strategy just because you hit a run of consecutive losses.
This is why day trading is so difficult.
But just remember that as long as you have a valid edge and you know your EV, you can be assured that you will be profitable in the long run provided you stick to your gameplan and manage your cash flow properly.