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Trading Is A Game of Numbers
Intro
Most retail traders fall into the category of technical traders—we use technical analysis to identify market patterns and hope to profit from the outcome. As a technical trader, most individuals over emphasize the importance of patterns, and this often results in an endless search for a strategy that has the highest possible win rate. While this seems like a common sense approach, there is no such thing as a trading methodology that always wins. Attempts to seek the “perfect” strategy causes most traders to overlook the true source of success.
The Game
The Cambridge English Dictionary defines a “numbers game” as:
“A situation in which the most important factor is how many of a particular thing there are”
In trading, the game is:
Despite the elegant simplicity, new and struggling traders are not able to think this way.
Why do so many traders struggle with the concept of a numbers game? I believe it’s because traders view the market as a predictable and stable environment that should respond to various forms of analysis in a consistent way. Therefore, anytime the market does not behave the way a trader anticipates it should, the trader is forced to conclude they are doing something wrong. If the trader happens to put on three or four losers in a row, they will likely abandon their entire approach and start from scratch. Such behavior seems logical. After all, if a trader loses four times in a row there must be something wrong with their approach, right?
For those who are trading randomly with no real game plan, consecutive losses can certainly indicate a poor methodology. However, if the trader is using a full fledged out strategy that has produced historical gains on the ticker in question, it’s just as likely that they’ve been caught in the randomness and volatility of the market.
If the trader is using a controlled risk parameter, like risking 1% of their account on each trade, 4 consecutive losses is only a drawdown of 4%. With proper risk and profit management, it should only take 2 consecutive winners to pull back those losses. In fact, I have personally experienced 4 losses in a row, followed by 4 winners in a row using identical trading variables. Had I changed a single variable to hypothetically avoid 3 of the 4 losses, I would have also missed 3 of the winners.
Let’s illustrate this example with real numbers. My risk was a maximum of 2% of my trading account, but my strategy defines moments when to exit early to minimize losses. My first target was 1.5 times my risk, and my second target was a trailer so I could ride out potential winners to the maximum extent.
If you go to the data window below this post, and click on the List of Trades tab, you can see for yourself how this looks. In addition, the performance summary tab shows you that my average losing trade was about $400, and my average winning trade was $957. Furthermore, the largest winning trade was over $2400 because I used a trailing stop loss. Had I stopped trading this strategy, or began altering my variables, I would not have experienced the winning trades.
While most people focus on avoiding losses, they fail to realize that hindcasting (using hindsight to adjust your strategy) can result in missing many winning trades as well. It’s a delicate balance between winners and losers. Remember, trading is a numbers game, and to win a game of numbers, you must think over a large sample size.
Most retail traders fall into the category of technical traders—we use technical analysis to identify market patterns and hope to profit from the outcome. As a technical trader, most individuals over emphasize the importance of patterns, and this often results in an endless search for a strategy that has the highest possible win rate. While this seems like a common sense approach, there is no such thing as a trading methodology that always wins. Attempts to seek the “perfect” strategy causes most traders to overlook the true source of success.
The Game
The Cambridge English Dictionary defines a “numbers game” as:
“A situation in which the most important factor is how many of a particular thing there are”
In trading, the game is:
- How many trades you win and lose
- How much you gain when you win, and how much you sacrifice when you lose
Despite the elegant simplicity, new and struggling traders are not able to think this way.
Why do so many traders struggle with the concept of a numbers game? I believe it’s because traders view the market as a predictable and stable environment that should respond to various forms of analysis in a consistent way. Therefore, anytime the market does not behave the way a trader anticipates it should, the trader is forced to conclude they are doing something wrong. If the trader happens to put on three or four losers in a row, they will likely abandon their entire approach and start from scratch. Such behavior seems logical. After all, if a trader loses four times in a row there must be something wrong with their approach, right?
For those who are trading randomly with no real game plan, consecutive losses can certainly indicate a poor methodology. However, if the trader is using a full fledged out strategy that has produced historical gains on the ticker in question, it’s just as likely that they’ve been caught in the randomness and volatility of the market.
If the trader is using a controlled risk parameter, like risking 1% of their account on each trade, 4 consecutive losses is only a drawdown of 4%. With proper risk and profit management, it should only take 2 consecutive winners to pull back those losses. In fact, I have personally experienced 4 losses in a row, followed by 4 winners in a row using identical trading variables. Had I changed a single variable to hypothetically avoid 3 of the 4 losses, I would have also missed 3 of the winners.
Let’s illustrate this example with real numbers. My risk was a maximum of 2% of my trading account, but my strategy defines moments when to exit early to minimize losses. My first target was 1.5 times my risk, and my second target was a trailer so I could ride out potential winners to the maximum extent.
- 4 consecutive losses produced a drawdown of about 7%
- 4 consecutive winners produced a gain of 26%
- Total gain of about 19%
If you go to the data window below this post, and click on the List of Trades tab, you can see for yourself how this looks. In addition, the performance summary tab shows you that my average losing trade was about $400, and my average winning trade was $957. Furthermore, the largest winning trade was over $2400 because I used a trailing stop loss. Had I stopped trading this strategy, or began altering my variables, I would not have experienced the winning trades.
While most people focus on avoiding losses, they fail to realize that hindcasting (using hindsight to adjust your strategy) can result in missing many winning trades as well. It’s a delicate balance between winners and losers. Remember, trading is a numbers game, and to win a game of numbers, you must think over a large sample size.
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