This is a small chapter in the book that will attract criticism. If you have ever heard that I disappeared under mysterious circumstances, it may be because of some content in this chapter.
The next few pages are not intended to scare you, but to tell you some facts about the transaction. I want you to know some of the pitfalls lurking there, and these pitfalls are waiting for traders who are credulous and do not know the truth. If I can keep you from taking detours and prevent you from falling into these traps, your chances of success will be greatly improved. Pre-warning is to prepare in advance.
You will often hear amazing returns. You will hear the salesman boast about a 90% win rate, a 95% win rate, and so on. You will also hear someone claiming that it is possible to win many consecutive trades all the time.
So what's wrong with winning? It feels great to win, right? Well, the salesman tries to sell you a product or service that promises such a high winning rate (or sometimes a ridiculous number of consecutive wins), relying on your desire to win to short-circuit your thinking.
It is easy to achieve a 90% win rate but still lose money. In contrast, there are many successful traders whose number of losing orders exceeds the number of winning orders. The ratio of profitable orders has nothing to do with the ultimate success of the trader. Frequent mention of trading win rate is just a sales strategy, and the purpose is to cater to the desire of traders to "win".
The ridiculous thing about the high winning percentage
Do you want to know how to create a high winning percentage? As long as there is no stop loss when placing an order (breaking all the rules of risk management, but this will definitely lead to a loss), and the profit can be realized quickly. In that case, we can hold on to each position until the position turns into profit or we receive a margin call.
If this sounds ridiculous, it is because it is inherently ridiculous, but this point must be emphasized. I am sad to tell you that this is how many people trade. They will be lucky for a period of time and get a relatively good return, and then they will suffer a large loss, leaving the account short of a big mouth. The ratio of their profit and loss orders is still amazingly high, but their accounts will suffer severe losses.
People are indeed teaching so-called trading techniques, promising to make multiple consecutive single profits. I have heard promises of profit for 20 consecutive orders, 50 consecutive orders for profit, or more.
This is similar to tossing a coin 50 times in a row, expecting that every time the coin falls, the "head" is up. This trader will not only almost certainly lose money after long-term trading, but to make matters worse, he still spends money to learn this technique that will inevitably lead to losses from someone.
Know when to retreat
Obsessed with the ratio of profit orders to loss orders is like a disease, and I am determined to stop this disease from spreading in our trading lives.
I want you to imagine yourself as a general, leading soldiers in battle. Your most important asset is your soldiers. You have to use them wisely and decisively. When attacking, you send them out to fight, but if the fight fails, you must retreat. Otherwise, you will sacrifice your warrior's life needlessly and weaken your overall strength. Your goal is not to win every small battle, but to win the entire war.
The transaction is similar. In order to win the war, you sometimes have to lose a small part of the battle. Or to be more precise, you must be willing to use small losses to prevent large losses.
Most major trading losses are due to traders' unwillingness to bear small losses, from Nick Leeson's collapse of Barings Bank to the fiasco of Longterm Capital Management. There are many other countless major trading losses, all of which are followed by failure to adopt a strategy.
"Strategy with 95% Win Rate"
In order to verify my point of view, I opened a demo account and used this strategy to place an order. I will stick to the losing position until it turns into a profit, and then quickly cash in a very small profit (see Figure 20.1)
I placed a total of 20 orders, 19 profit orders and 1 loss order, and the winning rate was 95%. Some people might think that a 95% win rate will definitely generate a very substantial profit, but as you can see, this is not the case.
Because this trader cashed in profits too quickly and was too willing to stick to a losing position, despite having a super high winning rate, this so-called strategy still resulted in losses. Unfortunately, this situation is too common.
I hope this little experiment can inspire us and help us not be brainwashed by sales strategies that promise extraordinary winning rates. If we allow salesmen to disrupt our insights with unrealistic or impossible dreams, this will only delay our ultimate goal of successful trading in the real world.
Beware of the pitfalls of backtesting
There is nothing wrong with back-testing a strategy in itself. In fact, back-testing is a very valuable tool in the process of strategy development. However, some unscrupulous operators use this strategic development tool to turn it into a weapon against the credible trading public.
Back-testing is the process of using historical data to improve trading strategies. Traders conduct back-testing strategies to determine how effective they have been in the past. This method has a hypothetical premise that what was effective in the past will continue to be effective in the future.
Since the market is not static, it is constantly evolving and changing, so back-testing is not a panacea. The past does not equal the future. As the market changes, good traders are gradually adapting, and the best traders are the ones who can adapt to this change the fastest.
We know what happened in the past and it is easy to find strategies that have a higher chance of success in the past. Since we cannot go back in time to trade, the effectiveness of these strategies is limited. But this has not stopped individuals from selling this retrospectively optimized strategy as a viable opportunity to make money at the moment.
It is said that someone once used back-tested and distorted returns as true returns to raise funds from credible investors. Now, this person has been sued by the Cornmodity Futures Trading Commission, allegedly because he falsified the performance of the backtest data and defrauded large amounts of money from credulous customers.
There are a few unethical people who try to use the impressive hypothetical return as a sales tool and sell back-tested and optimized strategies to those who are gullible.
Whenever someone tries to impress you with a strategy that has so-called high returns, be sure to ask that person if the result is real or hypothetical. Too many people think that the hypothetical return is the true return, but this is not the truth.
Hypothetical returns are not derived from real transactions, but often from back-testing. Now that we know how easy it is for a person to create seemingly good results just by back-testing, it is clear that we should never be too tempted by those hypothetical returns.
Perhaps one day in the distant future, humans can finally create a time machine. If that happens, the rewards of this back-tested optimized strategy and hypothesis will indeed become extremely valuable. But before that, the effectiveness of these tools has been greatly limited because we cannot trade past market conditions.