The ultimate goal
of every trader is to increase his/her profits. One can argue that there are
many ways to do that, but eventually it comes down to two main methods: increasing
your hit rate or maximising your winners.
INCREASING THE HIT RATE
Increasing your
hit rate means that you will have more winners than losers on average. The bad
news is that it’s basically impossible to be right more than 60% of the time in
the long run.
Generally, when
you see people showing very high hit rates, they have many small winners and a
few big losers. So, in the end, they are either unprofitable or they make small
gains.
You can increase
your hit rate by selecting only high probability trades where you have a very high conviction. That will require patience and strong discipline and
even then, you might not go far above the 60% threshold.
If you don’t
believe me that it’s basically impossible to have 80% or 90% hit rates in the
long run, let me introduce you to the greatest money-making machine in history:
the Medallion Fund.
The Medallion Fund
is part of the Renaissance Technologies Hedge Fund, which was founded by an
American mathematician called James Simons.
The Medallion Fund
employs complex models and algorithms developed by the smartest people in the
world using cutting edge technology.
From 1988 to 2020,
the Medallion Fund generated an annualised average return of 66% with not even
one negative year. Do you want to know the fund’s hit rate? It’s just 50.75%.
So, before you go
out there with all the best intentions to try to be the only one who has an
incredible hit rate, you should know that many tried and many failed. You don’t
want to be this guy…
MAXIMISING THE WINNERS
Now, going back to
the second way to increase your profits, it’s all about maximising your
winners. You can do it in two ways: increasing your risk to reward ratio or
increasing your position size on very high conviction trades.
Increasing your
risk to reward ratio doesn’t mean that you just start to have very tight stop
losses because that would actually increase the risk of being stopped out
prematurely. It means that you should look for trades that you expect to
develop over a longer period of time like for example the long USD/JPY trade in
the past 2 years.
On the other hand,
increasing the position size on very high conviction trades comes with some
risk and it’s not advisable for novice traders. Moreover, it’s better to do it
with fundamental catalysts and not technical analysis. Fundamental catalysts
are things like data releases, unscheduled reports, central bank policies and
so on. The bigger the surprise, the bigger the reaction. The best ones are
those where there’s a big surprise and it’s in line with the big picture
direction.