Compare Trading Strategies

📈 TRADER PSYCHOLOGY

🎢 Which Strategy is Better 🎢

What a better risk strategy - one that loses $300 on one thousand 💸 or one that loses $100,000 on a million? 💰

The logic says the former, but almost all of us say the latter because like all people, we react with our hearts ❤️ rather than our heads 🤯. The prospect of losing $100,000 is far more terrifying than the idea of losing $300 bucks even though in percentage terms, the $300 is a much worse loss 📉.

Money is also the reason why it’s easier to double a small account rather than a big one 💼. Doubling an account is always a function of taking on way too much risk (even if it doesn’t seem like that at the time). The classic rule of thumb is that in the best strategy, your drawdown should be about 1/2 your return, which means to make 100% you need to be willing to lose 50% 📊. Again, this is much easier to do with a $1000 account than a $100,000 one or even a $10,000 one. After all, getting margin out on a $1000 account is far less painful financially which is why the smartest thing that traders who trade without stop - otherwise known as the “trade and pray” method 🙏 - could do is open multiple small accounts rather than keep all your capital in one. You will for sure get margin out in a few of them, but you may get lucky 🍀 and catch a mean reverting market that will make all your average down trades turn green and double or even quadruple your equity and pay for all those margin stops.

Trading is full of these non-intuitive tricks 🧠.

Take a look at the equity curves below. Which one looks better? 📈 They are both trading the exact same strategy with the exact same pairs on the exact same time frame.

They are both positive but the second chart just above looks much worse. Yet that one trades with a 5:1 risk-reward ratio ⚖️. It risks 50 pips to make 250. If you read every standard trading book in the world, it will tell you that this is a great approach. After all, the better the risk-reward ratio, the less accurate you need to be to win 🏆.

Now look at the chart on the first chart. What do you think? 1:2 risk-reward? 1:3? 1:4?? How about 1:5! That version risks 250 pip stops against 50 pip gains. That’s insane on the membrane! 🧠 You need 83% just to break even on that approach. And yet, crazy as it seems, trading over a 42-month time frame across all the seven major pairs, the strategy hit winners 89.5% of the time, beating the breakeven spread handily 🥇.

But what’s even more amazing about the two charts is the steepness of the drawdown. You would think that a strategy that loses five times more than it wins would have stomach-churning equity dips - but it doesn’t 🌊. Sure, it has drawdowns but they are quickly recouped as the high winning percentage makes up for the losses 📈. The approach second approach however, has some very sharp drop-offs as trade, after trade, after trade gets stopped out ❌.

And now you begin to understand why insurance companies make so much money 💸 while many venture capital funds do not. In trading as in business, common sense is often unconventional 🔄.