The legendary George Soros once said, “It’s not whether you’re right or wrong, but how much money you make when you’re right and how much you lose when you’re wrong.” For many traders who’ve been successful in the game for years, this quote alone may just sum up the whole concept of trading.
Being right is an innate human desire as it makes people feel superior and validated. In the context of forex, however, having this feeling can be a negative thing. It’s fair to assume making any sum of money requires one to have some win rate. To the uninformed person, this percentage could seem quite high.
While some strategies need a relatively great win rate to be profitable, this certainly is not the case for every trader. This quality is what makes trading currencies advantageous. A trader doesn’t need to predict the markets correctly all the time to make money.
Being correct at all times itself is a virtually impossible task. This article will cover how the win percentage changes based on the trading style, frequency and why risk-to-reward is the critical factor for making profits.
Short-term traders and higher win percentages
One of the attractions for scalping and day trading is the realization of quick gains. Hence, this group’s profit targets are often smaller because their holding time is comparatively shorter.
Most of these traders use a risk-to-reward (R: R) ratio typically not above 1:2. This means for every dollar they put down. They plan to make at least $2. Some traders even use a 1:1 or lower ratio.
One of the advantages of having relatively tiny ratios like this is that the price doesn’t need to travel far to realize a profit, drastically reducing the waiting period. Let’s assume a day trader’s average R: R is 1:1, and their average stop loss distance is 40 pips.
Here, their average profit target would also be 40 pips. But why do scalpers and day traders need a higher win percentage to come out profitable in the end with these parameters?
It all boils down to two things, though the more significant factor is, of course, losses. If the trader lost just three trades in a row, that is 120 pips down. Thus, the trader would need to win three positions to return to their breakeven level.
We should also appreciate that every trader experiences a random distribution of winners and losers, meaning it could take a while for one to reach back to their previous point. The last element for needing a somewhat high win percentage, while less significant, comes down to covering the spread or transaction costs.
So, although short-term trading is attractive, it’s challenging to maintain a higher win rate if we appreciate that no ‘holy grail system’ exists with trading currencies.
Long-term traders and lower win percentages
Now let’s observe long-term speculators such as swing traders and position traders. Most traders generally don’t favor these two approaches since the trading frequency is a lot lower. Essentially, one does not trade for quick gains.
Such methodologies rely far more on patience, holding positions for very long, and an overall approach of ‘quality over quantity.’ The R: R ratios tend to be at least 1:5, meaning the trader aims to make $5 for every dollar risked.
In some cases, it is possible to realize ratios well above 1:5 depending on the set-ups, skill, experience, and adding of positions. Let’s assume a swing trader’s average stop loss size is 50 pips. With a 1:5 R: R ratio, for argument’s sake, their average profit target is 250 pips.
If this trader experienced a three-trade losing streak (150 pips) as the day trader did in the previous example, one 250 pip gain would comfortably cover this shortfall back above their initial point.
Therefore, it’s logical to conclude long-term traders fare well even with win percentages less than 50% because of the potential bigger gains. Moreover, spreads or commissions have minimal bearing on the trader’s profits, if at all.
How the stop loss size affects the winning percentage
Something worth mentioning is the stop loss size, how it varies across traders, and its effect on the winning percentage. It is possible to make a profit quickly in currencies, but this comes at the risk of using a tighter stop loss.
However, this practice is almost always a bad idea since price fluctuates quite strongly, meaning it can easily knock out a trader’s orders often. On the other hand, using a wider stop loss allows traders to remain longer in their position but at the expense of a tremendously reduced reward potential and waiting long for its realization.
This premise works fine for long-term traders but is difficult for scalpers and day traders. Many systems designed on short-term gains use lower R: R ratios by purposefully trading with a larger stop.
Although this technically results in a higher win rate, the rewards are lower, and the price will take longer to reach the desired targets. In summary, the higher percentage a trader seeks to achieve, the more they compromise the stop loss distance.
The winning percentage only matters so much
We’ve just seen how a higher trading frequency means a higher win percentage, while a lower trading frequency tends to equal a lower win percentage. So, how often a trader wins does matter but only to a small extent. What’s essential is maximizing the gains to cover up any losses along the way.
Final word
One of the biggest misconceptions, specifically for newcomers, is believing one needs to be right 100% or most of the time. A successful trader rarely thinks in this way. Instead, they will focus on managing their positions where their profits are always marginally greater than their losses.
The winning percentage only matters so far based on someone’s trading frequency (as already exemplified). Arguably, it is more important to focus on maintaining a favorable risk-to-reward ratio over time.
Therefore, there isn’t technically an ideal win rate in forex. A trader with a so-called 90% win rate may have less profit overall than someone with a 40% win rate because of how each individual handles their gains and losses consistently.
