How the Winning Rate of a Trader Can Fool You

By | September 15, 2014

A very common mistake of inexperienced people comparing trading systems is to put the greatest importance on winning rate. Let’s take 2 traders with 3 years of track-record each. Both have an average annual return of 40%. Trader A has a 75% winning rate, and trader B a 35% one. That’s all we know about them. Which one sounds more attractive to you? Which one would you choose to manage your account? I think most people would choose trader A. Their logic goes, he wins much more often than the losses. He obviously is better.

The success rate of trades is the least important performance statistic and may even be inversely related to performance. – William Eckhardt

Actually, I would choose trader B, and so would any professional trader. Why is that? Because he has incorporated a lot of room for error in his system, making him safer than trader A. While novice investors and traders look at the 75% rate and think that’s a sign of greatness, I look at it as one prolonged losing streak away from blow up. A professional knows that the losing streak is not a question of ‘if it will come’ but one of ‘when it will come’.

What we can see by looking at the winning rates and the annual returns is that trader B is much better at cutting losses short and letting profits run. Trader A is relying too much on being right (he might trade on hope, letting losing positions float, expecting the market to come back and rescue him) and that makes him much more vulnerable. While he’s been successful so far, a change in market dynamics (rising volatility, stronger trends) could virtually wipe him out.

We thus come back to an often repeated fact on my website, in one form or another: the way one manages the risk of ruin will make the difference between failure and long-term success in trading.