Most new traders think that trading is about winning trades, but that is not the case. Win rate means relatively little in trading. There is something much more important that determines whether you’re a profitable trader in the long run.
You can be profitable even if you only win 50% of your trades.
That means you can lose half of your trades and still make money consistently. In this post I’ll show you how to do that and I’ll expose the truth about win rate.
Risk to reward is much more important than win rate
Having a high win rate is not that important. What is important is your Risk to Reward Ratio (RRR). That really determines how profitable you are.
It is possible to make more profit by winning 50% of your trades than if you would win 70% of your trades.
Let’s say you have a win rate of 50% and a RRR of 1:2. In addition, you are willing to risk 10% of your total account of $1,000 on a trade.
- Win rate: 50%
- RRR: 1:2
- Account size: $1,000
- Risk: $100 (10%)
- Reward: $200 (20%)
If you take 10 trades you would win 5 and lose 5 (50% win rate), it would look like this:
5 x $200 profit = $1,000
5 x $100 loss = $500
$1,000 – $500 = $500
10 trades with a 50% win rate with a RRR of 1:2 will therefore give you $500 profit in this example. Despite losing 50% of your trades.
Now let’s look at a trader with a 70% win rate, but with a worse RRR of 1:1 and see the difference.
- Win rate: 70%
- RRR: 1:1
- Account size: $1,000
- Risk: $100 (10%)
- Reward: $100 (10%)
In this case he risks $100 to win $100. So his stop loss is just as far from his entry as his take profit order.
If he takes 10 trades he would win 7 and lose 3 (70% win rate), it would look like this:
7 x $100 profit = $700
3 x $100 loss = $300
$700 – $300 = $400
10 trades with a 70% win rate and 1: 1 RRR will only earn him$400. Even though this trader only loses 30% of his trades.
In this example, the trader with a higher win rate makes less profit. So it’s easy to see that a trading strategy with a high win rate, but a poor RRR is simply less profitable.
RRR is therefore much more important than win rate.
As you can see in the chart above you “only” have to win 33% of your trades to break even if your RRR is 1:2.
That means if you have a strategy that gives you an edge which allows you to win more than 1 out of 3 trades… You’re making consistent money. IF you stick to an average RRR of 1:2.
What should your risk to reward ratio be?
Always go for an average risk to reward ratio of 1:2. This means that you win twice as much on a winning trade, then you lose on a losing trade.
So if, for example, you risk $100 on a trade, your target must be $200 on average. I am not saying that you should risk $100 on a trade, I use these numbers because it is easy to calculate. 😉
I say that on average you should go for 1:2, because you will never always get 1:2 exactly. Sometimes your RRR will be 1:1.5 ($100 risk / $50 reward). On another trade your RRR might be 1:3 ($100 risk / $300 reward). But over the span of 100 trades, you should end up with an average of 1:2.
If you can’t get a RRR of 1:2 because of your trading rules there is no trade and you move on to the next.
What should your win rate be?
To be able to deal with mistakes, as a new trader you should have a win rate of between 40% and 50%. That may sound low, but you will make mistakes and you just have to take that into account.
And the nice thing is that with a risk to reward ratio of 1:2 you’ll still make a profit if you lose 60% of your trades.
After 6 or 12 months you want to grow to around 60% win rate. By then you should be a better trader. But again it is not necessary. Your risk to reward ratio is much more important.
So a 40% to 50% win rate is great for a starting trader or investor. If you win only 40% of your trades there is nothing wrong. You will get better with practice.
What you need to focus on is your risk to reward ratio, because that is the biggest determining factor in whether you make a profit or not.
You want to be a profitable trader, you don’t want to win the most trades.
Questions about risk to reward ratio in combination with win rate? Post them in the comments.