Suppose your trade has a 40% chance of success. A winning trade makes you $2 and a losing trade makes you $1. Should you make the trade? - PresentTrading
1. Winning rate
Suppose 100 trades are recorded, 40 of which are profitable and 60 are losing trades. In this case, the winning rate is about 40%. Although the method has produced 60 losing trades, it does not necessarily negate the effectiveness of the trading system.
This is where many traders get confused. Yet some of the most profitable trading systems have a win rate of less than 50%.
There is no point in increasing your winning rate. The key is to "not let your losses exceed your profits."
2. Profit factor
“Don’t let losses exceed profits” - PresentTrading
Therefore, when evaluating trading systems, the "ratio of profit and loss amount for each transaction" is the key.
The advantage of keeping a trading diary is that you can know the average profit and loss of your trading system and calculate the profit and loss ratio:
Profit-loss ratio = (Win rate (%) × Expected profit) ÷ (Odds (%) × Expected loss)
3. Kelly Criterion
The profit-loss ratio can basically explain the trading system, but how much should we invest in each trade?
In fact, there is a tool Kelly Criterion that helps you calculate what percentage of funds should be allocated to each investment to limit losses and maximize returns in the long run. KC calculates the percentage to be invested = (Win rate (%) - (Odds (%) ÷ Profit and loss ratio)) Example: Win rate 40%, odds 60%. Profit and loss ratio is 4, then 25% of the principal should be invested.
Ask yourself again:
Suppose your trade has a 40% chance of success. A winning trade makes you $2 and a losing trade makes you $1. Should you take the trade?
the answer is:
First make a transaction record, calculate the winning rate, profit factor and Kelly Criterion, and then make a decision.
"Evaluate strategies based on data calculations & backtesting and make logical, objective trading decisions." - PresentTrading