By Chuck LeBeau
If you have reviewed the systems that we offer for sale you will find that these systems tend to have a high percentage of winning trades. This is no accident. Although it is not essential for a system to have a high winning percentage in order to make money, there are many advantages for those systems where the frequency of profitable trades exceeds the losers. Here are a few of our observations on this important subject.
1. Systems with a high winning percentage are much more rewarding psychologically. No one enjoys losing. Everyone enjoys winning. Systems that encounter frequent losers and rely on occasional big winners to make money are not enjoyable to trade. Unfortunately the moral of the trader is not a performance measurement that typically appears on a historical performance summary but perhaps it should be. Strings of losses are demoralizing regardless of your attitude or experience. Strings of profits are always fun and build confidence and self-esteem as well as building your bankroll.
We often hear about excellent systems that are abandoned by their operators in spite of a long-term record of profitability. These tend to be trend following type systems with a low winning percentage. It would take the faith and patience of Gandhi to trade some of these systems in spite of their appealing long-term track records. It should not be surprising that most traders fail.
2. Systems with a high winning percentage are likely to have lower drawdowns. Assuming that the worst case loss on a per trade basis is strictly limited, as it should be, abnormal drawdowns are most likely to be caused by a long string of trades wherein there are very few winners. Large drawdowns are rarely the result of a long string of consecutive losses. Drawdowns are most likely to be caused by the absence of regular profits. Perhaps I am saying the same thing two different ways but I think there is a difference. For example six losses in a row followed by a winner and another six losses in a row is likely to produce a larger drawdown than ten losses in a row. Obviously the higher the winning percentage the less likelihood of stringing together a long series of trades with only occasional winners. Of all the historical performance factors that we can evaluate, the winning percentage is most likely to be predictive of the possibility of large drawdowns. If we can design a system that has a low average loss and a high winning percentage we are looking at a system that should be very drawdown resistant.
3. Systems with a high winning percentage reinforce discipline. How often have we heard stories of traders who are following a system and after a series of losses decide to skip a trade only to have that skipped trade turn out to be a big winner? This is not the trader's version of an urban legend horror story. It actually happens very frequently. If we are trading a system with a low percentage of winners, it becomes increasingly tempting to start skipping trades. Lets assume we are trading a system that only has 30% winning trades. Since the odds appear to favor our skipping trades we will tend to be rewarded for our lapses in discipline. For a while we will benefit from skipping trades until we inevitably skip the big winner. That is usually when the system is abandoned because, having skipped the winner, we aren't about to jump back in to experience the next string of losses.
On the other hand, if our system has a high percentage of winning trades, we shouldn't be tempted to start second-guessing the system. We know up front that if we skip a trade the odds are that we will be skipping a winner. The favorable odds of the system will help us to maintain the necessary discipline to operate the system exactly as it was designed.
4. Systems with a high winning percentage require less diversification. The typical trend following system is extremely dependent on finding markets where a very large trend will occur. These large trends are relatively rare and to make certain that we are in the right market at the right time we must diversify our trading among many markets because we can't afford to miss one of those big trends. By diversifying as much as possible we are more likely to catch the big trend that makes back all of our losses and rewards us with a profit. However, in spite of what some portfolio strategists would have us believe diversifying a low percentage system actually increases the likelihood of a major drawdown rather than decreasing it.
However if we are trading a system with a high winning percentage we have much less need for diversification. And if by careful design our high percentage system is also capable of catching big trends, we have the best possible scenario. After all, there is no logical reason that a system with a high winning percentage can't also have big winning trades now and then. It all depends on the effectiveness of our exit strategy. Of course, diversification will still benefit our high percentage strategy but it will be an optional enhancement rather than a necessity.
5. Systems with a high winning percentage require less capital to operate. If we need less capital to survive drawdowns and less capital for diversification, it follows that we need less capital to start trading the system. Also, with a high winning percentage we can be more optimistic about starting with less capital and using our profits to build up our capital prior to any major drawdown.
6. Systems with a high winning percentage are easier to troubleshoot. Imagine a low percentage system where long strings of losses are the norm. How many losses will it take to get your undivided attention and tell you that something is seriously wrong? Too many, I suspect.
Now imagine a system with a very high percentage of winners. Almost any series of losses is going to be out of the ordinary and will quickly attract our attention. Hopefully we will be able to perform a prompt review of the system and correct any faults while we still have some capital left. Unfortunately if we are trading a low percentage system we could run out of capital before we realize that our low percentage system has deteriorated even further.
As you can see we are strong advocates of systems with high winning percentages. In our opinion there is no excuse for designing a system with a low percentage of winners. We contend that it's not really difficult to design a system with a solid winning percentage if you focus on that statistic and make it a requirement. Too often system designers tend to focus entirely on total profitability. Many times this emphasis tends to result in letting profits run too long (curve fitted profit exits) and perhaps using stops that are too close. Both of these preferences will hurt the winning percentage and degrade the system. On the other hand, if we set out to have a high winning percentage we can obtain it without sacrificing much, if anything, in the way of profits and we will create a system that is extremely "user friendly" and reliable.
*Reprinted with permission by Chuck LeBeau at www.Traderclub.com