You have heard it before: Trade structure and money management are the most important components of a profitable trading strategy (see “Simple money management wins over time,” January 2012), and while you can’t dismiss the role played by entry and exit logic, order triggers are significantly overrated as the key contributor to profitable long-term results.
Surveys suggest that professional traders are successful about 60% of the time. Certainly that is not a bad success rate, but that is not why these traders make money.
Indeed, you can make a lot of money and be wrong 60% of the time. In the previous article, we presented the results of a test on the U.S. Dollar Index futures contract using a simple set of rules to ensure proper trade structure. There was no logic to entry/exit decisions at all. A coin flip initiated a sequence of trades. The results were a disappointing 38% success rate, losing on eight trades and making money on five.
Despite that dismal performance, the strategy made money. The reason was simple enough. Winning trades made more than losing trades lost. Winners averaged $1,100, and losers averaged $572. The net gain was $920 on a cash commitment of $3,500. The annualized rate of return was 70%.
Surely, all traders have heard the axiom, “You must make more on your winners than you lose on your losers to be successful.” It probably is the single most ignored element of the average trader’s approach and the main reason that 90% of traders, or more, fail over time.
Traders have losing trades and lots of them. It doesn’t matter what strategy you use. To assume otherwise is naïve. Still, most traders choose to operate in that zone, and shoot for that rate of success. It is liberating to embrace that no single trade has better than a 50/50 chance of producing profits, despite your best efforts. That is reality.
This brings us to something you can control: Money management.