Win Ratios. A Flawed Concept.
The last two-weeks we’ve been having the Trading & Portfolio Management Mastermind sessions for DeltaOne.
Inevitably questions are asked about trading concepts and beliefs and they should be to clarify approaches.
Before I get into this, let me say this: investing/trading frameworks are never the same across any investor or trader.
Just this week we were reviewing a few intraday-strategies and I asked some of the traders to disclose entries/exits.
On 5 of them all of the entries were different. Relatively close, but different.
Does that matter? No. What matters is they all saw the breakdown of a trade and put on short risk to execute on it, that is what matters.
So what I want to get into in this post are my views on this idea of win ratios:
Why they are a flawed concept
What most are really after when they are after high win ratios
This discussion is more for those running money & larger portfolios because the game is different at that level.
But if you’re a beginner reading this maybe there’s some value to it as well.
It’s not my intention in this post to convince you to use or not use them but to show you why I, among others, don’t really care about them when it comes to trading and never care about them with actual investing.
Why Win Ratios are a Flawed Concept
I want to start by saying a few things here to give context. I’d never once even heard about win ratios being discussed when I was a PM/analyst/trader. There has never been a book or hedge fund manager great that I have read that has discussed them either.
In fact, one of the best fund managers (and his team of other PMs’) have been on record numerous times stating their win ratios are 50%-55% right.
That guy is the Goat Steve Cohen.
I shouldn’t have to explain who this guy is but if I do google him so you understand why this should be taken seriously.
I am going to unpack that paragraph in a few moments but let’s start with the foundation.
Win ratios and the pursuit of 80%-90% win ratios are:
Unrealistic
A narrative used to market the retail trader/investor by people who don’t manage risk
Steve Cohen is not the only large trader that has stated this, there are many others and many portfolio mangers that are from SAC that have left to start their own hedge funds that have taken this belief as well.
It’s an accepted reality.
While I never worked at SAC Capital he was the first hedge fund manager when I was 17 that got me interested in any of this because I simply read an article about how some guy paid $16 million for a house in Greenwich, CT (a lot of money back then).
From there reading anything about him and how he conducted his views on capital markets/trading was what I did - so it should be no surprise that his view on this topic (and others) are close to, if not identical to, my views today.
“They’re not right 80% of the time, I’ve got to sit there and use my judgement. See what the markets are telling me.”
That’s an important line.
I’ve got to sit there and use my judgement.
Most traders/investors either are not confident in their judgement or just know that they’re not skilled enough to be able to judge the market - in fact, the latter, is a good thing because at least you can admit you don’t know what you don’t know.
Most won’t.
There is not one situation in the markets where it is always the same. You need to learn to analyze each situation and trade independently.
This might be contrarian to what you have learned and if so you have a lot of unlearning to do.
Most retail investing & trading that is out there (that I have had the displeasure to witness) loves to tell everyone that they have a “trading setup” that works 80% of the time (or whatever arbitrary number).
“Use this one trading setup to get results”
“This indicator has a 90% win rate” - just plug it in no thinking required.
Thinking IS required - a lot of it.
But the fact is this: most of you don’t want to think and that’s cool because you don’t have to especially if you use the TLV Membership.
I’ll do the thinking and analysis for you.
But for those of you that manage your own capital, it’s a must.
Most take this idea of win rates and try to replicate it or forever on the search for the perfect trade.
They’ll do that until they realize:
Don’t do that.
You need to learn to analyze the market and trade(s) situation by situation.
If this is you and this is resonating you might have a lot to unlearn.
You can start here with this 90 minute Webinar: Hedge Fund Manager Exposes Why 90% of Retail Traders Lose.
The second line he says is: See what the market is telling me. I can always come back later to see what has changed.
People tend to see a trade (especially momentum traders) as their trade being isolated.
What I mean is they think that their trade has no correlation to the S&P500.
In any major hedge fund, especially pod shops (imagine you have $200 million and you allocate that to 7 managers to run it, not just one trader/portfolio manager) you have to be beta neutral.
What that means is each trader has to look at how their positions correlate with the S&P500 to ensure the expected change in the portfolio is near zero.
In retail trading, which is mostly intraday positions, they are anything but beta-neutral and that’s not a bad thing (to be non-beta neutral in an intraday strategy).
But most don’t realize that they are correlated and they fail to do what Cohen said above: “See what the markets are telling me”.
So this idea that you can go after a trade setup or strategy that works 80% of the time without analyzing the market at large is short-sighted.
What Most are After With High Win Ratios
What most are after in my experience with this topic of win ratios are the following.
They want a high win ratio so they can then allocate more capital to that particular trade when and if it set’s up - this is flawed.
They don’t want the emotional pain/struggle of losing so they’ll do whatever they can to avoid it even if it means displacing it to this concept.
Higher win ratio = more capital. I first saw this in 2014 when I was teaching futures - I had no idea what people were saying when they kept asking me about win ratio or why they wanted to know. But they were obsessed with it and what was later realized is that in their minds, the higher win ratio they could find meant that the more contracts they could trade.
Talk about a flawed concept. You’re after a concept that does not exist and even when it does I’d challenge any of you to try to then trade 100-200 contracts on SPX or Crude Futures and see how you feel, even with your win ratio back tested.
(On a side note, this is prevalent for whatever reason with amateur futures/forex traders, they are on some constant hunt for win ratios because they want to trade more risk - what I think they fail to realize is that the asymmetric edge in FX/Futures taps out - in fact if you are after asymmetric edges then, options, growth stocks and tail risk ideas are where you really should be looking - you’re going to make more risking less in those markets and it’s less stress.)
And I talked about this above but we’ll rehash this quickly.
The higher the win ratio means there must be some trade setup that equates to one putting more capital risk into the idea.
Again, that’s flawed.
Most portfolio managers have risk limits (I did when I was a PM and there are still used in the fund).
Not saying that you should use them but if people that do this at an elite level do it shouldn’t you consider that as well?
Most people don’t because a new stock pick is just that: a pick that has to be “the one” so instead of managing it as just another investment people:
A) Have capital destructed
B) Off to your next journey to back-test again to find a trade setup that works
You never solve THE problem.
BUT THIS IS RETAIL INVESTING & TRADING.
High win ratios mean that this trade has a certainty to it and if that’s true then I don’t have to think or be emotionally stressed when doing it.
Again, in my experience this is one of the utilities of high win ratios, to reduce the stress because “it will work”.
First, trading and investing is not supposed to be fun. You have one job as someone managing your money: to make more of it.
This is business, it’s ruthless, it’s hard and it’s your money.
If you want a stress-free approach to this then get a trust fund so you can blow money and not care (I’ve met a lot of people like this and they do that exact thing), allocate your money to an advisor or buy and hold stocks.
My expectation on any trade is not that it will not work so how much am I out if I lose.
That approach, that mindset, keeps me from going above risk models.
If you go above a risk model at any fund/firm your a$$ is fired, no questions, but retail traders/investors do it all the time.
Joel Greenblatt, another hedge fund manager, was asked in this interview here a question and one of his replies was this:
Because unless you bought at the all-time low the stock goes down after you, or the investment goes down after you bought it right.
Expectations. They matter.
And this expectation of using high win ratios to alleviate your mental pain or so that you can add more size/risk/money to an idea is the fast way to the poor house.
Final point.
Most of you might be looking at this from the traders perspective and not the investor perspective.
The other night I was having dinner with someone from DeltaOne when he was in Phoenix and we go to talking.
A lot of what I do is buy companies, not stocks.
When a portfolio is built I am buying a company - the earnings, the management, the FCF, the macro environment that affects a sector…(Like housing short this year).
Never in my mind does a win ratio come into play.
There’s a distinction here that most don’t connect because most only are trained on technical (breakouts, head shoulders shampoo pattern, MACD and other BS).
I don’t take that approach when it comes to ideas where you are throwing large sums of money at it and you can probably look at investors like:
And countless others…and none of them are using the idea of win ratio.
The idea is portfolio risk. How much risk is this investment going to take in the portfolio, what’s the downside and what can we make.
Really, read the posts I’ve had on housing short on the main site.
In no instance did the idea of win ratio come into play.
Some summary bullet points:
Every investment idea is different, especially value or macro trading ideas.
There are repeatable price patterns and scenarios that do have a higher chance of working but you still have to assess the market at large, not just that stock or setup.
High win rates don’t mean added risk/capital.
Thanks for reading.
This article is presented for informational purposes only, is an opinion, is not intended to recommend any investment, and is not an offer to sell or the solicitation of an offer to purchase an interest in any current or future investments. Any such solicitation of an offer to purchase interest will be made by a definitive private placement memorandum or other offering documents.