Thursday, August 14, 2014

What You Need to Know about Strategies Accuracy

“Markets change continuously. Therefore, I am constantly searching for trading setups that may improve my trading.” – Christian Lukas

One of the most important aspects of a strategy is its accuracy percentage. High accuracy is more preferable than low accuracy, although it must be coupled with positive expectancy. A trader whose strategy is only 25% accurate can end up winning if she/he uses an RRR of 1:5, small sizes and run their profits. This is something that requires maturity and patience. On the other hand, a trader whose strategy is 75%+ accuracy can end up blowing his portfolio when she/he uses a worse expectancy like risking $20 to gain $2, doesn’t use stops, runs losses indefinitely and uses big sizes.

Having said this, why would most traders still find trading so challenging despite the fact that they use stops and optimal lot sizes? The answers are not far-fetched.

You need to know that the position sizes for huge portfolios aren’t the same as the position sizes for small portfolios. Traders who speculate on small accounts would be frustrated when they try to follow the trend. Trend-following is good, but it requires patience, discipline and ability to handle long losing periods. That’s why it’s better done on huge portfolios. The overall accuracy of strategies that follow the line of the least resistance is so low, especially now that false breakouts are no longer a curiosity and sustained trending moves are rather rare. Such are today’s markets. 

The retail trader finds it difficult to increase their portfolio balance because they use strategies that have low accuracy in most cases. One way to drastically reduce the difficulty is to look for ways to increase your strategy accuracy. Accuracy of 40-50% is certainly better than an accuracy of 25-35%.

This is a fact of trading: When your accuracy is high, it would be easier for you to recover your losses and move ahead. When your accuracy is low, recovery of losses would be more difficult. The wider a take profit level is, as compared to a stop loss level, the more difficult it would be for the take profit level to be hit.   The tighter a take profit level is, as compared to a stop loss level, the easier it would be for the take profit level to be hit.  A tighter take profit level makes sense when strategy accuracy is high, because the stop loss level would even be tighter and the positive expectancy incorporated into the system would be rational.  

This is another fact: The higher the accuracy of a system, the less frequent and the more fleeting its losing periods would be. The lower the accuracy of a system, the more frequent and the more protracted its losing periods would be. A trading method whose accuracy is 30% will usually lose more than 20 trades in a row when a losing period materializes; whereas a trading method whose accuracy is about 50% will usually lose less than 15 trades when a losing period materializes. The higher the accuracy, the fewer the losses in a losing period.

We tend to gain money in markets, but we give some of it back during a losing period. Someone says it’s not easy to keep money that’s made from the markets. By letting profits run and hoping for a target to be hit, we sometimes end giving back some of our profits, but we want to give back as little as possible. We do this by using small lot sizes, increasing our accuracy, using a rational RRR that’s commensurate with the rate of accuracy, and temporarily stop trading after a weekly or monthly drawdown limit has been reached.

Conclusion: The retail trader would do well to look for a strategy that has a higher accuracy, so that the trading experience can be easier and losing periods reduced and more short-lived. Please learn from your past mistakes and adjust your trading style accordingly. When a good football team gets defeated, they learn a lesson. When they win, they also learn a lesson. This is one of the factors that improve their performances in spite of recent failures. This is also true of trading.

This article is ended with the quote below:

“I have traded now for 13 years and I still have yet to have a year where my winning percentage is over 50 per cent. I posted a 100 trade experiment in 2008 where my win/loss was 48.32 per cent yet the account grew 57.47 per cent.” – Adam Jowett

Learn from the Generals of the Markets: Market Generals

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