From the April 2013 issue of Futures Magazine • Subscribe!

Avoiding trading paralysis by analysis

Also in “Questionable curves,” the green curve tracked the equity of a system that won nine out of every 10 trades. However, its reward-to-risk ratio was only 0.091. Plugging those numbers in, we get another losing strategy:

(90 / 100) * (0.091) - [(100 – 90) / 100] = -0.018 

The lesson here is that you can’t evaluate a trading system with just the reward-to-risk ratio or just the winning percentage. You need both figures to determine the viability of your trading system. “Pick your system” (below) shows the expectancy of various reward-to-risk ratios with respect to their winning percentage. This chart provides a quick comparison of a number of values for each statistic. For example, a system with a reward-to-risk ratio of three-to-one and a winning percentage of 60% would be superior to a system with a reward-to-risk ratio of 1.5-to-one but a winning percentage of 90%. (And both of these would be exceptional systems, by the way.)

As we can see, many different combination sets of reward-to-risk and winning percentage produce winning strategies. You can make money with a low reward-to-risk, and you also can be profitable with a small winning percentage.

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