“A prudent question is one half of wisdom.”
— Francis Bacon
Prior to discovering the first (and perhaps foremost) of my simple day trading rules, I (like pretty much everyone else) thought a high win rate was the most important thing in trading… especially day trading. It’s “well settled” that if you win more than you lose as a trader, you’re bound to make money correct? And if you win substantially more frequently than you lose, you will make lots of money right?
Not so fast young man…
I recently had a gentleman (we’ll call him Fred) reach out with a problem he was experiencing in his intraday trading. The essence of our conversation is paraphrased below. We pick up after the pleasantries:
Fred: So I can’t seem to make any headway with this day trading thing. I do the research and only trade companies with wide intraday ranges, but my account stays around breakeven at best. Any thoughts?
Trader: I would have to look at your trades in detail, but I’m guessing you need to learn one of my simple day trading rules and lower your win %.
Fred: I need to WHAT? You mean improve my win rate don’t you?
Trader: No… I mean lower it.
Fred: Uhhh… I think you better explain that one.
Trader: It’s simple… I’m guessing you do about as well as anyone else picking the stocks you trade and following a decent plan, but you fall victim to the need to be “right…” So you keep losing positions way too long and jump out of winning positions far too quickly. Jumping out of of your trades with small wins helps you feel good and probably keeps your win rate north of 50 or 60%…
Fred: (proudly) 73%
Trader: But doesn’t add anything to your bottom line… thus rendering you a proud peasant.
Fred: I don’t get it…
Trader: Think of it this way, if I give a you choice between a day trading strategy that wins $1 99% of the time and loses $100 1% of the time or an approach that makes $100 1% of the time and loses $1 99% of the time, which would you want?
Fred: $1 99% of the time? That means a 99% win rate? That’s the one I would want for sure, but I’m guessing this is a trick question…
Trader: No… it’s not a trick question… although it IS a bit tricky for most investors. It has to do with the way most of us have been taught since early childhood. The higher “win” percentage has always been better because it was the result that was rewarded. The higher “win rate” got the better grades, the better sports record, the better dates, the better job… the better “life.” It would seem that we could simply transfer that framework to day trading and press play…
Fred: One would think…
Trader: Doesn’t work that way. In trading generally and day trading specifically, the magnitude of the wins and losses matters just as much as (arguably more than) the frequency of wins and losses. In the case of the 2 strategies above, to win $1 99% of the time with a chance of losing $100 1% of the time seems like the better bet because you get to be “right” way more often than not. It just feels better. However, if you were to simulate that system over lots of trades you would find that the net outcome would be a loss. Every time.
Alternatively, if you simulated the results of the 1% chance of winning $100 to the 99% chance of losing $1 over a large number of trades, the net result would be positive. This is what’s known as expectancy and it’s way more important than just a win/loss %. In fact, I would go so far as to say it is the KEY to successful trading… and perhaps foremost of my simple day trading rules.
Fred: Ok… I think I get that. But how does that mean I need to lower my win rate?
Trader: (Laughs)… I said need for effect… all else equal, a higher win rate is always better. The point was to get you to focus less on keeping your win rate high and more on the size of the wins relative to the losses… In other words, cutting your losses short and letting your winners run (another of the core day trading rules). Known as lose fast and win slow… as long as the losses are quick, small losses and the winners are relatively big (I normally say slow, but the wins needn’t be slow… though the bigger ones often are), this may seem counterintuitive at first. However, this tenet is literally the dividing line between successful traders and losing traders, no matter what time frame you trade.
Click this image for more on this key trading principle
Fred: Ohhhhh… I see… So, in other words, you HAVE met someone who went broke taking a profit…
Trader: Maybe not broke… but they certainly didn’t make any money trading that way.
The point about win rate…
In trading as in life, “things ain’t always what they seem.” You need not look very far to find trading services offering trading approaches and trade ideas with super high win percentages.
They’re misleading you.
Follow at least this of my simple day trading rules… Pay more attention to the average win size vs the average loss size along with the frequency and magnitude of each.
You’ll be glad you did.