The ultimate goal of every trader is to increase his/her profits. One can argue that there are many ways to do that, but eventually it comes down to two main methods: increasing your hit rate or maximising your winners.
INCREASING THE HIT RATE
Increasing your hit rate means that you will have more winners than losers on average. The bad news is that it’s basically impossible to be right more than 60% of the time in the long run.
Generally, when you see people showing very high hit rates, they have many small winners and a few big losers. So, in the end, they are either unprofitable or they make small gains.
You can increase your hit rate by selecting only high probability trades where you have a very high conviction. That will require patience and strong discipline and even then, you might not go far above the 60% threshold.
If you don’t believe me that it’s basically impossible to have 80% or 90% hit rates in the long run, let me introduce you to the greatest money-making machine in history: the Medallion Fund.
The Medallion Fund is part of the Renaissance Technologies Hedge Fund, which was founded by an American mathematician called James Simons.
The Medallion Fund employs complex models and algorithms developed by the smartest people in the world using cutting edge technology.
From 1988 to 2020, the Medallion Fund generated an annualised average return of 66% with not even one negative year. Do you want to know the fund’s hit rate? It’s just 50.75%.
So, before you go out there with all the best intentions to try to be the only one who has an incredible hit rate, you should know that many tried and many failed. You don’t want to be this guy…
MAXIMISING THE WINNERS
Now, going back to the second way to increase your profits, it’s all about maximising your winners. You can do it in two ways: increasing your risk to reward ratio or increasing your position size on very high conviction trades.
Increasing your risk to reward ratio doesn’t mean that you just start to have very tight stop losses because that would actually increase the risk of being stopped out prematurely. It means that you should look for trades that you expect to develop over a longer period of time like for example the long USD/JPY trade in the past 2 years.
On the other hand, increasing the position size on very high conviction trades comes with some risk and it’s not advisable for novice traders. Moreover, it’s better to do it with fundamental catalysts and not technical analysis. Fundamental catalysts are things like data releases, unscheduled reports, central bank policies and so on. The bigger the surprise, the bigger the reaction. The best ones are those where there’s a big surprise and it’s in line with the big picture direction.
