Weekly Update: Win/Loss Ratio
Good evening, and welcome to this week’s edition of Stealth Trades!
What a week. After several weeks of selling and pullbacks in just about every leading stock, the Nasdaq rallied this week to gain 3.5%.
The stock market has an uncanny ability to embarrass the greatest number of people. When everyone thinks prices are going higher, they collapse. The public is finally bearish? Stocks start to rise.
Trying to predict where the market will go week to week can be one of the most frustrating endeavors a person can undertake.
Last week, after the selloff in NVDA stock following a blowout earnings report and an accompanying decline in the Nasdaq, I was nearly certain the market would fall further this week.
It did not. I was wrong. And, unfortunately, that is part of the game.
Trading is a game of probabilities. You are going to pick losing stocks. There will be weeks when you are not in tune with the market. The trick is to be right more than you are wrong, and to make more than you lose.
There are two statistics every trader should be tracking – win rate and win/loss ratio.
Let’s start with the win rate…
This one is pretty simple. What percentage of the time are you right? Or what percent of your trades are winners versus losers?
If you made money on 6 trades and lost money on 4, your win rate would be 60% (6 out of 10 trades were profitable).
Most people focus on this stat exclusively. I get asked in webinars all the time, “what is the percentage of your winners to losers?”
But that is only half the equation.
I’ve seen traders with win rates over 80% that still lose money. There are charlatans in my line of work who tout huge win rates and claim to have “96% winning trades.”
Here’s the part they don’t tell you…
The other 4%? That tiny number of losing trades? They wipe out all the gains.
Why? Their win/loss ratio is horrible.
The win/loss ratio represents your edge. It is the ratio of your average profit against your average loss.
If your winning trades have an average profit of 12% and your losers average only -4%, your win/loss ratio is 3:1. In other words, you make three times as much money when you are right as you lose when you are wrong.
This is extremely important. Because your win/loss ratio dictates how often you need to win.
In the above example, a 3:1 win/loss ratio means you only need to be right 25% of the time. Every win offsets three losses, so as long as you can get 1 out of 4 right, you are not losing money. Any better than that, and your account balance is growing.
On the other hand, let’s pretend those numbers were reversed. Let’s say you have a bad habit of selling too quickly when things are going in your favor and holding too long when they are not.
If your average profit is 4% but your average loss is -12%, your win loss ratio would be 1:3. Now the equation has flipped. Since one losing trade wipes out three winning ones, you need to be right 75% of the time.
That’s harder to do.
Paul Tudor Jones is one of the greatest traders to ever live. His goal was a win/loss ratio of 5:1. He looked for opportunities where he could risk a dollar to make five.
Jones knows the power of a good win/loss ratio better than I ever will. That is his edge. He admits to losing far more often than he wins. Yet he still amassed a $7.5 billion fortune.
Below is one of my favorite Paul Tudor Jones quotes:
“The best profit-maximizing strategy is to own the fastest horse.”
I’m not Warren Buffett. I’m not looking for blue chips I can hold for two decades. I want to see my money grow quickly. So, I focus on the best-performing sectors and the fastest rising stocks within that sector.
I keep a watchlist of 62 sector ETFs. ITB represents home building stocks. IBB tracks biotechnology. There are others for basic materials, semiconductors, etc.
I flip through these charts every week to see what areas are showing the most strength. You can also sort them by 1-month relative strength score in platforms like Deepvue which I am playing with now.
Below is a screenshot of the top 5 groups today.
Uranium, cybersecurity, oil & gas, biotechnology, and software stocks are currently the best performers. So, I want to focus on the best stocks in those groups.
This simple process reduces 6,000+ publicly traded stocks down to a watchlist of 20-30. And that is where I focus.
Are they all guaranteed to go up? Of course not. But an object in motion tends to stay in motion. And stocks that are going up tend to keep going up.
So, once again, you are putting the odds in your favor.
The Global X Uranium ETF (URA) currently holds 43 stocks. Yet 24% of its assets are in one stock – Cameco Corp (CCJ).
I can see why…
This is a beautiful trending stock ripping to new highs. I like it.
The second-best sector over the last 30-days has been cybersecurity. A quick glance at the ten largest cybersecurity stocks (and one of IHAK’s top holdings) uncovered Vmware (VMW).
VMW is completing a 2-year cup and handle pattern that looks poised to breakout higher.
Heavy buying volume, support at the 50-day moving average, and high relative strength are all the things I look for in a fast-moving stock.
In a nutshell, this is my process. Focus on strength and buy the best. Stack the odds in your favor with as many variables as possible.
Trading is hard enough. Don’t make it any more complicated than it needs to be. Focus on the leading stocks in leading groups. You are almost guaranteed to be in some of the best performers.
Best wishes for your trading,
