Trading Tip 14: Understanding Winning Percentage

Let's say you purchased or developed a system that has a winning percentage of 70%.

What exactly does that mean?

It means that the probability of having a winning trade is 70%, i.e. it is more likely that the trade you are currently in turns out to be a winner than a loser.

Does that mean that when you trade 10 times you will have 7 winners? - No!

It means that if you trade long enough (i.e. at least 40 trades) then you will have more winners than losers, but it does not guarantee that after 3 losers in a row you will have a winner.

Let me give you an example:
If you toss a coin then you have 2 possible outcomes: head or tail. Probabilities are 50%, i.e. when you toss the coin 4x then you should get 2x head and 2x tail.

But what if you tossed the coin 3 times and you got 3 times 'head'?
What are the probabilities of 'head' on the next coin toss?
50% or less?

If you answered 'less' than you fell for a common misconception. The probabilities of getting another 'head' is still 50%. No more and no less. But many traders think that the probabilities of 'tail' are higher now because the three previous coin tosses resulted in 'head'. Some traders might even increase their bet because they are convinced that now 'tail is overdue'. Statistically this assumption is nonsense and a dangerous and many times costly misconception.

Let's get back to our trading example: If you have a winning percentage of 70% and you had 9 losers in a row, what are the probabilities of having a winner now? - It's still 70% (and therefore there's still a 30% chance of a loser).

It's important that you understand this concept!

Let's say you purchased or developed a system that has a winning percentage of 70%.