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The contest between "win rate" and "profit and loss ratio": How to choose in cur

2024-06-25

For traders, to achieve profit targets, there are generally two directions of effort: continuously improving the trading win rate or continuously expanding the profit-to-loss ratio. Theoretically, the profit-to-loss ratio and the win rate are in balance with each other. The higher the profit-to-loss ratio, the corresponding win rate will be lower, and vice versa. So in trading, should investors pursue the win rate or the profit-to-loss ratio?

Profit-to-loss ratio vs. win rate: High win rate does not necessarily mean a sure profit.

The win rate, as the name implies, is the probability of winning. If you make 10 trades and make money 6 times, the win rate is 60%. The profit-to-loss ratio is the ratio obtained by dividing the average profit points of multiple trades by the average loss points of the stop-loss. If each trade makes a profit of 15%, but the stop-loss range is 5%, then the profit-to-loss ratio is 3.

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Theoretically, the market is in a volatile trend for 80% of the time and in a one-way trend for 20% of the time.

Taking international gold as an example, when the market is in a volatile trend, shorting when the gold price rises to the vicinity of the previous high dense resistance area, with a stop-loss of 3 yuan and a take-profit of 9 yuan, or a stop-loss of 5 yuan and a take-profit of 15 yuan (selecting the plan according to market fluctuations); or longing when the gold price falls to the previous low dense support area, with the same take-profit and stop-loss plans. But no matter which plan (the profit-to-loss ratio is 3:1), as long as you succeed in 3 out of 10 trades (win rate of 30%), you can make a profit.

Stop-loss of 3 yuan x 7 times = 21 yuan, take-profit of 9 yuan x 3 times = 27 yuan, profit of 27 - 21 = 6 yuan

Stop-loss of 5 yuan x 7 times = 35 yuan, take-profit of 15 yuan x 3 times = 45 yuan, profit of 45 - 35 = 10 yuanBut what if the situation is reversed? With a win rate of 70% and a profit-to-loss ratio of 1:3, the long-term trading outcome is still a loss. This example fully illustrates the tendency of investors to overlook the importance of the profit-to-loss ratio.

The relationship between the win rate and the profit-to-loss ratio affects the final profit.

The above only reveals the tip of the iceberg regarding how the win rate and profit-to-loss ratio affect profits. The following will make hypothetical reasoning and statistics: assuming a monthly profit target of 5%, with an average of 60 trades per month. When the win rate drops from 70% to 35%, and the profit-to-loss ratio ranges from 0.5:1 to 3:1.

If the win rate is high (for example, 60-70%), a profit-to-loss ratio of around 1:1 can achieve the target;

If the win rate is 50%, a profit-to-loss ratio of 1:1 or 0.5:1 is an ineffective solution;

If the win rate is very low (for example, below 40%), a profit-to-loss ratio of 3:1 is more reasonable, and if it is 2:1, the trading risk is extremely high.

Real-world situations tell us that no one can guarantee to maintain a high win rate all the time.

Bruce, an American trading system design and application expert, has been engaged in trading since 1975 and entered the field of trading system research and design in 1976. He once said, "For professional traders, the percentage of profitable trades is often below 40%."

Even professional traders find it difficult to achieve a high win rate, let alone ordinary retail investors. In trading, the win rate is indeed a very important aspect. If there is a super high win rate, then the probability of making money is naturally high. However, the market is complex and changeable, and no technical system can guarantee eternal applicability. Spending too much effort on improving the win rate may have little effect.

Improving the profit-to-loss ratio is the key to profitability.From the calculation formula of the profit-to-loss ratio (profit/loss), we can find ways to improve the profit-to-loss ratio—by increasing the average profit margin, i.e., enlarging the numerator; or by reducing the average loss margin, i.e., decreasing the denominator.

The first method to achieve these two points is to increase the profit of each transaction and reduce the loss of each transaction. In the famous Wall Street saying, it is "cut losses short and let profits run." In this method, investors cannot control how far the profits can "run," but they can control the maximum loss of each transaction, which is the so-called stop loss.

How to effectively improve the profit-to-loss ratio?

Set the maximum loss margin for each transaction, or determine the exit conditions. Once the conditions are met, even if it is a loss, it should be sold to control the loss margin and avoid significant losses and being deeply trapped. This is also one of the important reasons for the importance of stop loss.

However, although the profit margin is difficult to control, the size of the position during profit and loss is controllable. This involves the second method of improving the profit-to-loss ratio—position management. Reducing the position of the loss and increasing the position of the profit can also improve the profit-to-loss ratio.

But the profit-to-loss ratio is a lagging indicator, which requires a lot of transactions to be statistically calculated. It is difficult to guide the entry through the profit-to-loss ratio, and forcibly setting the profit-to-loss ratio may turn profits into losses, or miss the market. Therefore, investors should make a good plan in the transaction. After making a profit according to the plan, the cost line can be set as a forced exit point, which can at least ensure no loss.

Under the premise of ensuring the floating profit space, you can moderately take profits to bet on a larger market to expand the profit-to-loss ratio. Over time, the profit space will also increase day by day. And when the winning rate and profit-to-loss ratio are determined, you can calculate the appropriate optimal position through the famous Kelly formula: q = p - (1 - p) / R (p is the winning rate, R is the profit-to-loss ratio).