inpilna
07-23-2006, 02:17 AM
Why traders loose with good trading systems...
A major misconception about a good trading system is that it should give a higher percentage of winners compared to losers, say 70% winners and 30% losers.
Amazingly very few traders understand, that the main characteristics of a great trading system is not how often it’s right, but how explosive a move is when it’s right.
Thus a system (like MTPredictor) that only gives about 38% winners and 62% losers can be considered a good profitable system. Why? Because when it’s wrong, your loss is limited to 1R (1 unit of risk), and when it’s right the average profit is about 3R.
So assuming that 2 out of 3 trades are losers, you total loss is –2R and your profit is +3R giving you total of +1R profit. If you translate it into real world numbers, when you risk 2% per trade of a $25,000 account, i.e. max. $500 per trade, it means that after each 3 trades (on the average) your equity increases by $500.
Many traders though would look at MTPredictor system and say, wow, it’s a great system if you use it in reverse! That is, when there’s a buy signal, you go short, and when there’s a sell signal, you go long. Why is it great? Because then, according to statistics, you are 62% right and only 38% wrong. It’s hard to argue with this logic, because we don’t know, how explosive is the move when you are on the right side of the trade. But proponents of this anti MTP system say that even assuming that you take profits at 1R, and loses at 1R you would comfortably make some money: +2R +(-1R)=+1R. So you get the same +1R profits with a lot less stress.
This puts a profitable system developer in a difficult situation.
- First of all, he has to provide users with average win/loss ratio. It’s probably can be done by using regular back testing. In MTPredictor case we know it’s about 38/62.
- Secondly, he has to show how explosive on the average the move is when the system is right. And not the maximum move, but the move based on standard management technique. This aspect is not well studied with MTPredictor and the developer admits that no back testing was done in this respect. But some of us know from practice, it’s approximately 3R.
- Thirdly, you can’t get discouraged after 2-3-4 losing trades and stop using the system, you have to take all the trades every time when a trade is triggered.
- Based on the 3 previous facts, the most important message the MTPredictor developer has to deliver to MTPredictor users (assuming they follow position sizing and honor stops): if you use this system, your loses are limited to 1R. When you have a winning trade, you HAVE to let it run using standard management technique to at lease above +2R and higher. If you take profits on a winning trade at +2R or earlier – you GUARANTEED to loose even using a proven profitable system like MTPredictor.
All of us remember fiasco with Surgical Strike approach, you take profits too soon – eventually you lose or break even. It just shows you that even experienced traders forget about this simple issue: with a system with percentage of winners below 50% you HAVE to let the profits run if you want to win with this system.
So, why do traders loose with good trading systems? Just think about it: you had 2 losses in a row (we know it can be 5-6 losses in a row), finally you have a break: a winning trade; you’re making 1R, then 1.5R and finally you take your profit too soon at 2R being anxious to protect the profit remembering your 2 previous losses. That’s why it’s so important for the developer to assure users that the system is tested, you should trust the system and you should expect to have 2 losers out of 3 trades, and that you absolutely have no choice but to (by using management technique) ride your winner to a minimum of above 2R and preferably to at least 3R.
A major misconception about a good trading system is that it should give a higher percentage of winners compared to losers, say 70% winners and 30% losers.
Amazingly very few traders understand, that the main characteristics of a great trading system is not how often it’s right, but how explosive a move is when it’s right.
Thus a system (like MTPredictor) that only gives about 38% winners and 62% losers can be considered a good profitable system. Why? Because when it’s wrong, your loss is limited to 1R (1 unit of risk), and when it’s right the average profit is about 3R.
So assuming that 2 out of 3 trades are losers, you total loss is –2R and your profit is +3R giving you total of +1R profit. If you translate it into real world numbers, when you risk 2% per trade of a $25,000 account, i.e. max. $500 per trade, it means that after each 3 trades (on the average) your equity increases by $500.
Many traders though would look at MTPredictor system and say, wow, it’s a great system if you use it in reverse! That is, when there’s a buy signal, you go short, and when there’s a sell signal, you go long. Why is it great? Because then, according to statistics, you are 62% right and only 38% wrong. It’s hard to argue with this logic, because we don’t know, how explosive is the move when you are on the right side of the trade. But proponents of this anti MTP system say that even assuming that you take profits at 1R, and loses at 1R you would comfortably make some money: +2R +(-1R)=+1R. So you get the same +1R profits with a lot less stress.
This puts a profitable system developer in a difficult situation.
- First of all, he has to provide users with average win/loss ratio. It’s probably can be done by using regular back testing. In MTPredictor case we know it’s about 38/62.
- Secondly, he has to show how explosive on the average the move is when the system is right. And not the maximum move, but the move based on standard management technique. This aspect is not well studied with MTPredictor and the developer admits that no back testing was done in this respect. But some of us know from practice, it’s approximately 3R.
- Thirdly, you can’t get discouraged after 2-3-4 losing trades and stop using the system, you have to take all the trades every time when a trade is triggered.
- Based on the 3 previous facts, the most important message the MTPredictor developer has to deliver to MTPredictor users (assuming they follow position sizing and honor stops): if you use this system, your loses are limited to 1R. When you have a winning trade, you HAVE to let it run using standard management technique to at lease above +2R and higher. If you take profits on a winning trade at +2R or earlier – you GUARANTEED to loose even using a proven profitable system like MTPredictor.
All of us remember fiasco with Surgical Strike approach, you take profits too soon – eventually you lose or break even. It just shows you that even experienced traders forget about this simple issue: with a system with percentage of winners below 50% you HAVE to let the profits run if you want to win with this system.
So, why do traders loose with good trading systems? Just think about it: you had 2 losses in a row (we know it can be 5-6 losses in a row), finally you have a break: a winning trade; you’re making 1R, then 1.5R and finally you take your profit too soon at 2R being anxious to protect the profit remembering your 2 previous losses. That’s why it’s so important for the developer to assure users that the system is tested, you should trust the system and you should expect to have 2 losers out of 3 trades, and that you absolutely have no choice but to (by using management technique) ride your winner to a minimum of above 2R and preferably to at least 3R.