Keys to winning
However, it is not that hard to develop a trading strategy that has a win rate of 40%. It is also not that difficult to structure trades that produce a two-to-one profit/loss ratio. Given that, the only factors preventing a trader from succeeding over time are not starting with a large enough account size and succumbing to the temptation to over-trade.
In the initial example, the trader needed $4,000 more than the margin requirement to make the trades. In the second example, $3,000 more was needed. In the worst-case scenario — 12 straight losers and then eight straight winners — the trader would need $12,000 more than the initial margin.
To demonstrate, consider an approach designed to achieve the minimum desired performance metrics: 40% wins and a two-to-one win ratio. Our tests cover dollar index futures from Jan. 19 through June 3, 2011. The rules are simple. On Jan. 19, we buy or sell the close based on a coin flip. Heads we buy, and tails we sell; in our test, the coin toss was heads, so we buy.
Regarding the profit/loss ratio, if price moves in our direction by two standard deviations, we take profits and initiate an opposite trade. If the market moves against us by one standard deviation, we take a loss and initiate a trade in the opposite direction. Our strategy is designed to manage our profits and losses to achieve our goals. The initial coin flip simply gets us into the market in an objective manner.
The goal of this strategy is that if we win, we’ll make two standard deviations. If we lose, we’ll lose one standard deviation. (A standard deviation is a statistical measure of price movement, or volatility, and virtually all charting programs offer it.)
Understand that this approach is for demonstration purposes only. The buying and selling is being done in this manner to achieve close to a two-to-one profit/loss ratio. There is no reason to assume that the trades will work, as the only logic is a volatility measure designed to set profit and loss points at desired levels.