Two trades in Crude Oil illustrate my approach to making money in the trading game. If there is a Holy Grail in trading, it’s reflected in the formula:
(Avg$Win x WinRate) – (Avg$Loss x Loss Rate) = > $0
In other words, what is important ( taking the win rate into consideration) is for our $ win to be greater than our $ loss.
To maximise the difference, I seek to exit a position BEFORE my stop is hit. So when I say that my trade has an 80% of success, this does not mean that I have an 80% probability of making money. Given that my win rate fluctuates between 47% and 55%, the comment “80% probability of making money” would be sheer nonsense. What the statement means for me: if I exit before my stop is hit, I have an 80% chance of being right. This means that in 80% of the time, if I had not elected for early exit, my stop would have been hit.
Figure 1 shows my results for 2006, my trading year is from September 1 to August 31. My aim is to make around 25% per annum. In 2006 I had a better than average result even though my win rate was slightly below 50%.
Figure 1 2006Results
But early exit comes at a price: there will be times that when exiting a position means I’ll re-enter at a more adverse price. This is what happened with the most recent Crude Oil trades.
Figure 2 shows a classical “Negative Development” buy setup and entry (For Negative Development see previous posts and Nature of Trends). Note that I use CSI’s Perpetual contract for analysis and the appropriate nearest futures month for stops and entry levels.
FIGURE 2 Negative Development
What I expect following Negative Development setup is strong continuation. Instead, we had two inside days. So, on Dec 11, I exited the position with a 0.36% loss. I exited not because the trade had done anything wrong, but because it wasn’t doing what I expected.
I did plan a re-entry on a breakout and this was triggered last night. This second trade can’t lose because I exited 1/3 at last night’s close, moved my stop to breakeven on the second 1/3 and left unchanged the initial stop on the last 1/3.
The early exit cost 0.36%. When you consider the difference between my initial exit and breakout entry, my loss on the trade was 0.42%. But I am happy to wear the loss which with hindsight need not have occurred. But that’s the point: only precognition of last night’s breakout would have kept me in the trade. And since I don’t have that skill, I was happy to bail and happy with the way I managed the trade.