In this week’s educational trading article, we would be discussing a topic that comes up in all our online trading academy classes – the topic is about your win/loss ratio. A better percentage of newbies and a few experienced traders believe that one needs an extremely high win/loss ratio to make profits in trading forex, futures, and stocks. Unfortunately, this isn't true.
Firstly, what is a win/loss ratio? As defined by Investopedia, the win/loss ratio is the ratio of the total number of trades a trader wins to the total number of trades he or she losses. And this doesn't include how much was lost or won, but if they were winners or losers.
If 6 out of 10 trades were wins, your win/loss ratio is 3:2 or 6:4, or say 60%. Many newbie traders believe this number is quite low. One of the factors that we think makes such forex, futures, and stock traders think this way is that they compare it to the exact grading scale they have had in their regular education experience. In the schools that we grew up in, 60% is a D grade, which borders on failing. In case you aren't familiar with our basic grading system, see it below:
90–100% = A
80–89% = B
70-79% = C
60-69% = D
Below 60% = F
Many amateur traders look at this win/loss ratio and compare it to their grading system in school. This is understandable, though – many of us were graded in this format for a better part of our formative years: from about fifth grade to high school, college, grad school, and so on. This age-long and deeply-rooted belief often discouraged many novice traders when they don't attain a trading performance that equates getting good grades in school. And it all boils down to the same thing: for years, we have been made to believe that to be successful, one needs to record at least 70, 80, 90%, or even higher sometimes. Unfortunately, in trading forex, futures, and stocks, that isn't true!
In our discussion with more experienced traders and investors, many affirm that their win/loss ratio is approximately 50%, or even below. And you think they are bad traders or failing students? Of course, not! When you focus solely on your win/loss ratio, you will miss out on the essential component of your average wins' versus your average losses. With an average gain of 20 pips/ ticks/ cents and an average loss of 20 pips/ ticks/ cents, your win/loss ratio must be over 50% to make any real money in trading the financial market. In our trading classes and investing courses, we recommend that traders and investors seek trades that offer them at least a 1:3 risk to reward ratio. We recommend this because of two reasons: one, you will look for trades with higher quality. Two, to make real money in trading, you do not need to have a very high win/loss ratio. If you have an average loss of 10 pips/ ticks/ cents and an average win of 30 pips/ ticks/ cents with a 50% win/loss ratio, in ten (10) trades, you would've gained 150 pips/ ticks/ cents and lost just 50 pips/ ticks/ cents. This leaves you with a net profit of 100 pips/ ticks/ cents, which of course, isn't bad!
The sooner you realize that the win/loss ratio isn't the most essential element in trading and investing in the forex, futures, and stock market, the better off you'll be. Having read books written by some legendary traders out there, we realized that these authors regarded their win/loss ratio many times as an afterthought. Most of them are very concerned about taking losses, which causes them to manage their trades extremely close. This makes them just take a few pips/ ticks/ cents or take their loss. Nonetheless, these people are great traders who know their onions and are very good at letting their winners run. When you take small losses of ten pips/ ticks/ cents nine times but have one big winner of 100 pips/ ticks/ cents or more (risk to reward ratio 1:9), you are still a profitable trader! It boils down to letting your winners run which we have discussed in many previous trading and investing articles that you can find on our website onlinetradingcampus.com. These legendary traders may have trades with a risk to reward ratio of 1:9! Although this ratio may be difficult for you as a newbie trader, finding a happy balance that aligns with your psychology is of utmost importance.
In the long run, actively managing those trades that are going against you and letting your winners run will eventually yield large profits! Learn how to manage your winners, and you can also be as right as a weather forecaster, and still double as a profitable trader!
If you want to learn more about professional trading and investing across multiple asset classes such as forex, futures, and stocks, please sign up for free at our online trading academy www.onlinetradingcampus.com and get access to a free three-hour introductory course.
Happy trading!