Can You Spot the Profitable Trader?

What does it take to get ahead these days?

Well, if you want a job at a big corporate, quite a bit apparently.

I have a friend who works at a big multinational in Sydney. She tells me it’s virtually impossible to get an interview without a degree.

Now that’s a big ask…especially for entry level positions. You may have a lot to offer. But this company might not look beyond the first page of your CV.

I remember a similar issue when I was starting out. It was all to do with grades.

You see, the top banks had a high entry hurdle. Graduates had to have a degree with a distinction average. While my grades were good, they didn’t quite meet the standard.

But I had a stroke of luck.

A friend was already working at a leading bank. He knew a part-time position was coming up in the dealing room, and he put my name forward.

The introduction made all the difference. It put me in front of the head of a trading desk. Yes, he had an interest in my grades. But it was his overall impression that got me the job.

I read an interesting article recently. It was about Google’s hiring process.

Laszlo Bock is Google’s senior vice president of people operations. He says that grades alone are worthless when choosing staff — they don’t predict anything.

Google instead looks for flexible thinkers who can adapt. They want people who can move outside their comfort zone and learn from mistakes.

Bock notes that grades don’t hurt. It’s just that Google is also looking at other things. This helps explain why a growing portion of staff don’t have degrees.

Yes, grades are a popular measure of ability. But in my experience — and Google’s — they only give one perspective. You need to look at other factors to get a full picture.

Hallmarks of a successful trader

Many people have a similar attitude to trading. Just as they link high grades to job performance, many also think a high win rate is a sign of a good trader.

Let me give you an example. It’s from a conversation I had a few years back at a wedding.

I got talking to a guest about trading. His goal was to trade for a living. I was working at Bankers Trust at the time, and my new friend wanted to know all about it.

One question sticks in my mind. He asked what my strike rate was. In other words, he was asking what percentages of my trades made money.

Without a second thought, I said about 35% to 40%.

I remember his response vividly. He said, ‘Oh, that’s honest.

There was a moment’s pause. Then it struck me. He thought a low strike rate was bad. In his mind, I was confessing that my trading career was in tatters.

I then added some key information. This made all the difference.

I told him my average winning trade was more than three times my average loss. This meant I was actually a very profitable trader. You don’t need a high win rate to make money.

But I can understand the confusion.

The internet is full of ads for all sorts of trading services. Many claim to have exceptional win rates. This plays on the thinking that ‘high grades’ equal success.

A tale of two strategies

I’m going to show a snapshot of data. It’s the individual win rates for a group of traders. I want you to have a look and then I’ll ask you a question.

Here’s the table…

Trader A Trader B Trader C Trader D
Strike rate 88.3% 72.1% 60.8% 60.1%

Now, suppose you want to hire a trader. Whose CV would you look at first?

I think most people would go with trader A. It’s that natural tendency to link a high grade with success. Why look at someone who gets it right less often?

But that’s only part of the story. Let me add some more information.

Trader A Trader B Trader C Trader D
Strike rate 88.3% 72.1% 60.8% 60.1%
Profit $53,269 $69,991 $85,271 $109,300

Trader A is no longer top of the class. It’s trader D making the most money.

Now, these aren’t random sets of numbers. They’re from some back-testing I did recently. My aim was to test two exit strategies: Taking profits, and letting winners run as I currently do in Quant Trader.

Here’s what I did…

I made some modifications to Quant Trader’s algorithms. The main change was to include a take profit rule. I set the system to exit a trade once it hit a certain level of profit. I then ran the tests over the last five years.

As always with my back-testing, each trade is for $1,000, and there is no allowance for costs or dividends.

Here’s the final table. It shows the results from four scenarios.

5% take profit 20% take profit 100% take profit Let profits  run
Strike rate
(closed trades)
88.3% 72.1% 60.8% 60.1%
$53,269 $69,991 $85,271 $109,300
Number of trades 1910 760 439 406
Ave profit per trade $29 $88 $153 $195

The first two strategies are similar to how many people trade. Locking in an early profit typically leads to lots of small wins. The problem with this is that it caps profits.

The third strategy gives profits scope to run. It then takes profit if a stock rises by 100%.

The final example is Quant Trader. Profits are left to run until the stock hits its trailing stop.

Now, you may be thinking the 5% take profit strategy isn’t that bad. It seems to make good money. And you get plenty of winners to boot.

But there’s a catch. Look at the number of trades. Now look at the average profit per trade. This strategy may well lose money after brokerage.

The 20% take profit strategy is a bit better…although it’s no standout.

It’s only when we let the winners run that things get interesting. The number of trades drop, and profits rise. The longer holding periods are also more likely to result in dividends.

I have one last thing to show you. The following chart brings all the numbers to life. It graphs the hypothetical performance of the four strategies.

Source: Quant Trader
Click to enlarge

There is no doubt about it. Letting winners run can make a huge difference. Sure, you’ll have a lower strike rate. But your winning trades will potentially be a lot more profitable.

Successful trading isn’t about being right more often…it’s about making money.

Until next week,

Editor’s note: Your exit strategy is one of the most important decisions you’ll make. Yet, despite its importance, selling is an afterthought for many traders. This can be a costly mistake.

Quant Trader uses a trailing stop to manage selling. This is an exit level the follows a share price higher. It won’t get you out at the top — that’s not how it works. The aim is to capture the big middle part of a trend. This is how the system has captured gains like 353% in Blackmores [ASX:BKL], 199% in Vita Group [ASX:VTG], and 147% in HUB24 [ASX:HUB].

So if you’re not sure when to sell…I strongly suggest you look into Quant Trader now.

Try it. See if it makes sense to you. It could change the way you trade forever.

Money Morning is Australia’s most outspoken financial news service. Your Money Morning editorial team are not afraid to tell it like it is. From calling out politicians to taking on the housing industry, our aim is to cut through the hype and BS to help you make sense of the stories that make a difference to your wealth. Whether you agree with us or not, you’ll find our common-sense, thought provoking arguments well worth a read.

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