Just tossing this out in hopes of getting newer traders to carefully consider their real-world, psychological capacity for trading low win rate trend following systems.
For example, let’s say a particular trend following system has a profit factor of 2.6, an average win/average loss ratio of 1.95, and a winning trade percentage of 43%. Multiply those three stats together and you come up with a score of 2.18.
However, imagine that you must eventually (in fact, it’s a statistical certainty over a large sample of trades) endure TEN losing trades in a row and its accompanying system draw down along the road to a series of long-term, consistent, new equity highs.
Just imagine if your first ten trades with that same system were losers; no matter how fantastic its real-world performance has been, you’re going to need a tremendous amount of psychological fortitude to be able to stay with that system. I suspect that most traders would not be able to continue trading it, and in fact would completely abandon it after 4-6 consecutive losers.
Now imagine a scalping system that wins on 87% of its trades, has a profit factor of 2.2, and an average win/average loss ratio of .50. The score for this system is 0.957. You will, on occasion, endure as many as five losing trades in a row, but mostly the losses will come at a rate of one or two in a row before the equity curve turns back up.
You can make a lot more money (with the same amount of shares/contracts) by trading the first system. However, if you can’t muster the psychological strength needed to deal with ten losers in a row, then the system can’t possibly benefit you, and in fact may cause you a tremendous amount of psychological and financial harm.
You MUST always count the cost - the psychological cost - to your trading psyche before you subscribe to any system. Make sure you have the capital, guts, willpower and courage to see the race through to the end - or don’t start at all.
Self-esteem psychologist Nathaniel Branden (from his book Self-Esteem Every Day (1998)) offers this wonderful, ancient Spanish proverb that sums the above situation up very nicely:
"Take what you want - and pay for it.’
In other words, make you best judgment about a system and your ability to trade it consistently, up front.Then be willing to stay with it through the inevitable good - and bad - times that you will experience while trading it.
