Many people, especially those who are new to trading, may have this false impression that trading requires a high win rate of 80-90% to be profitable. Such a myth is peddled through eye-catching online trading advertisements that promise easy and lucrative earnings from the forex market-if you follow trading gurus with high win rates. Some people can achieve such a high win rate, but they are the top few per cent of traders in the world. If you’re just looking for an alternative means of income outside your day job, you don’t need sky-high (80-90%) win rates to be profitable.
Understandably, the term “win rate” is attractive. It is an easy-to-understand, quantifiable measure of a trader’s success rate. Much like judging a person’s strength purely from his weight (or size). He may measure lightly on the scales, but there are also other factors that affect his level of strength.
You can be profitable in the long run even with a “low” win rate (30-40%).
Win rate is largely affected by the trading strategy you have in place, as well as how strictly you can follow your trading plan. For now, we will not dwell on this just yet but look at another area that influences your profitability which you can have more control over-risk-reward ratio.
The risk-reward ratio measures the potential profit for every dollar risked. This is something we can decide for ourselves. I adopt a risk-reward ratio of 1:3, e.g. risking $30 (stop loss) for $90 potential profit for every trade. Let’s look at the illustrations below to have a better understanding of how the risk-reward ratio can affect our profitability. Keeping the win rate at a constant of 50%, we can see that by adopting a risk-reward ratio of 1:3 and 1:2, we will still be in profit after 10 trades.
Risk-reward ratio 1:3
Look at the chart above, it shows the result of 10 trades by adopting a risk-reward ratio of 1:3 and having a win rate of 50%. There is an equal number of wins and losses after 10 trades (5 each). As the risk-reward ratio is 1:3, for every loss trade, the loss would be $30 and for every winning trade, the profit will be $90. The net gain after 10 trades is $300.
Risk-reward ratio 1:2
Similarly, with a conservative risk-reward ratio of 1:2, when we are risking a dollar for a potential 2 dollars profit, it is still possible to be profitable.
Risk-reward ratio vs Win rate
The chart above is a quick summary showing if you are profitable in trading by looking at 2 factors: the win rate and risk-reward ratio. The risk-reward ratio is something we have more control over by adjusting our stop loss and profit for our trades. Win rate is measured using our past trade records (I would suggest looking at least 50 trades) to find out our wins and losses.
Trading is a long term game, do not be too happy with a few winning trades (overconfidence) or discouraged by consecutive losses (fear). Your short term result provides insufficient data to be extrapolated to future profits. The key to a profitable trading career is always about CONSISTENCY, always find out the areas that you are lacking in and work on them.
May the pips be with you.