Quote from deaddog:
Let me do the math for you;
100 Trades; 35% win rate; risk: reward = 1:3; risk per trade = $100
65 losses x $100 = $6500
35 wins x $300 = $10500
Profit =$4000
Well I must interject here because I have done extensive evaluation of all the things discussed in this thread (win rate vs draw down & ruin, and TOTAL profit).
This will be a long post to prove beyond a doubt (I hope) that #1) win rate effects RISK OF RUIN and DRAWDOWN. #2) that profit is mostly related to your R return per winning trade but the lower the win rate the harder it is to keep your high R returns with a trend trading system because of the long losing streak you have when win rate is lower. If you do not wish to read the entire post then skip it. Bottom line,..the truth lies somewhere in between what everyone is saying but TrendTrader Jim is MOSTLY correct. See the following MC simulations to show why.
The MC simulations are running a 200 trade simulation in a year repeated randomly over 1000 times (you can do 10,000 as is typical but in interest of time I ran 1000,..results are essentially the same). It is assuming $100,000 starting acct and a risk of 1% with the 35% win rate system and 3.5% in a 80% system. I chose these numbers because they are numbers quoted above by deadog, Wide Tailz, kut2k, intradaybill and others. 1% risk is typical of most systems. I chose 3.5% risk with 80% win rate system because this is MUCH HIGHER than the 2% limit that most tout as being MAX RISK. The sims also take into account $7 commision per trade.
Lets look at 80% win rate and 3.5% risk first (80% & 3.5%). Wide Tailz is correct in that the higher the win rate the less money management rules come into play. This is because of the higher the win rate the fewer string of loser you get and the less draw down. See the 80% & 3.5% simulation and notice that the LOWEST PnL after 1000 trades is a 29% draw down (DD) during the simulation but FINAL LOW PnL is STILL POSITVE at +$41,000!! Thats 41% return. You will NOT have a losing year NO MATTER WHAT because you have so few losers in a row. Notice that MAX losing streak with this system is 9 in a row. Max winniner is 48 in a row!. You may also notice that I have chosen a losing trade as being 1 R (-$3500) and a winning trade as being 0.5R (+$1750) so that this is just a modest profit per trade and nothing out of the ordinary. You make less profit per trade but the outcome is relatively little draw down and 41% return MINIMUM,...average is 141% return and maximum is 220% return.
Conclusion, high win rate limits your max drawdown and allows you to risk more per trade with little or no risk of a losing year.
Now 35% win rate and 1% risk (35% & 1%). This system was given a 1R loser (-$1000) and a 3R winner (+$3000) as described by deadog above. Notice that the string of losers raises dramatically to a maximum of 26 in a ROW!! How many of you would continue to trade a system with 26 loser in a row? How many of you would trade it FAITHFULLY? I doubt any one would. I know if I had THAT many losers I would question my system and probably start changing it. This effects the outcome of the system as well and probably real world outcome would be WORSE than this simualtion which assumes you trade your system perfectly. We all know human error and emotions effect trading as well. With that many losers in a row do you think you can keep your emotions out of trading and trade your system perfectly?....DOUBTFULL!! Also notice that the MAX draw down is the nearly the SAME (-30%) as the 80 & 3.5 system. However, even IF you traded your system PERFECTLY you still run the possibility of having a losing year with -$14,600. Average profit is a solid 79.8% (+$79.8K) and max profit is also impressive at 165%.
Conclusion, despite much larger wins (3R) the large number of losers in a row will effect your outcome dramatically. You still have a substantial risk of a losing year but on average you will profit. With lower win rate systems you have a wide disparity in your overall profit at year end and increase your risk of a losing year despite the higher profit when you win.
Final conclusion is win rate effects drawdown and risk of ruin but does not effect profit. You can run these simulations any way you want,...I have and the conclusion is the same. So everyone is sort of correct.
Think of trading a low win rate system like the lottery which is the ULTIMATE low win rate system. For example,...In the lottery you risk $1 to win a profit of $250 million. But your win rate is exceptionally low (1/300 million for example). This is the extreme example of a "trend trading system" like 35% & 1% above. So again Profit is NOT effected by win rate as you stand to profit $250 million with minimal $1 risk but your string of losses will make this "system" highly likely to result in a losing year and cause you to stop trading it.
I hope this helps. Good Luck.
N54_Fan
