Two traders compare notes. One wins seven trades in ten, and the account is shrinking. The other wins four in ten, and the account is growing. Neither is lucky. The difference is two numbers that only mean something together, and a third that most traders never work out: how many losses in a row their strategy should expect.
Two numbers that only work together
Words you will meet
R
What you risk on one trade: the distance to the stop loss, in money. A loss of 1R is one ordinary losing trade.
Win rate
The share of trades that win, counted over enough trades to mean something.
Risk to reward
What a winning trade pays for each 1R a losing trade costs, written 1:2 for a target twice the size of the stop.
Expectancy
What one trade is worth on average, win or lose, in R. Above zero is an edge.
Break-even win rate
The win rate at which a risk to reward neither makes nor loses money, before costs.
Losing run
Losses in a row, also called a losing streak.
Drawdown
The fall from the account’s highest point to its lowest point after it.
Your edge in one line
1:2 means each losing trade costs 1R and each winning trade pays 2R, R being what you risk on a trade.
+0.20Rper trade, on average
Over 100 trades
Net +20R
Break-even win rate 33%
An edge: small, but repeated a few hundred times it adds up.
- 33%the win rate a 1:2 strategy needs to break even, before costs
- 50%the win rate a 1:1 strategy needs
- 75%the win rate a strategy needs when it risks three to make one
Spread, commission and slippage come out of every trade, winners and losers alike. They push the break-even win rate up, and they hurt a strategy with small targets the most.
The losing run is part of the plan
A 40% win rate means six trades in ten lose. They do not take polite turns with the winners: they bunch. Deal a hundred trades and see.
40 winsLongest losing run 8trades 24 to 31
Deal again: the runs change, the arithmetic does not.
How long a run to expect
Trades
A losing run of the expected length is not a sign that the strategy has stopped working. It is the strategy working, at the win rate it has.
Behave the way the strategy expects
Without the numbers
- Five losses in a row: “it has stopped working”
- Raises the risk to win it back
- Closes winners early to “bank something”
- Changes the settings every few weeks
- Gives up in the middle of an ordinary run
With the numbers
- Five losses in a row: “normal, I planned for fourteen”
- Keeps the same risk on every trade
- Lets the target work: the reward is half of the edge
- Judges the strategy over a hundred trades or more
- Is still there when the run ends
Five steps before the next trade
- 1Find the numbers
In the Strategy Tester report: profit trades as a share of all trades, the average profit trade, the average loss trade and the maximum consecutive losses.
- 2Work out the edge
The expectancy from the win rate and the risk to reward. Above zero after costs, or no trade.
- 3Work out the run
The run to plan for over the trades you expect to take in a year, plus a few more, because markets bunch their losses.
- 4Size for the run
A risk per trade at which that run costs an amount you can sit through without changing anything.
- 5Decide what would make you stop
Written down in advance: a run or a drawdown well beyond the plan. Then review calmly, never in the middle of an ordinary run.
Where each figure is in the report: how to back-test an Expert Advisor in MT5.
Where an Expert Advisor fits
An Expert Advisor takes the fifteenth trade after fourteen losses exactly as it took the first. The only question is whether the trader lets it. Every K3Bxn Expert Advisor places a predefined stop loss and take profit on every trade, so what a trade risks and what it aims for are set before it opens. Your part is to know the numbers and choose a risk that makes the expected run boring. Next: why the trader, not the strategy, is usually the weakest link.
Check yourself
3 questions
A strategy risks 1R to make 2R. What win rate does it need to break even, before costs?
One winner pays for two losers, so one winning trade in three is enough to break even.
Which has the edge: 70% winners at 1:0.33, or 40% winners at 1:2?
0.4 × 2 − 0.6 = +0.2R a trade, while 0.7 × 0.33 − 0.3 = −0.07R a trade.
A strategy that wins 40% of its trades has just lost eight in a row. What does that tell you?
At 40%, the typical longest run in 250 trades is nine losses in a row.
Know your numbers
Tick what is true for you. It is kept on this device.