ES Thursday 10-27-16 : Hot Topic

The Perfect Trade

What should we aim for?

Do you need to be perfect? Does every trade have to be a winner?

Your life to date

Take a look at your test and exam results from school. How often did you score 100%? If you are exceptionally good at your subject then this will happen but for most of the population this rarely happens. We strive for A's - whatever they may be. That might be over 70 or 80 or 90%. Sometimes a pass is all that we can hope for. Depending on where and what is being examined a pass mark can be as low as 40%. I hope that doesn't apply to brain surgery.

The Perfect Long 10 Minute Trade

In the perfect long trade you enter at the low tick of the move on a limit order and exit on the high tick at your target, also using a limit order. There are so many things that have to be right to pull off the 100% perfect trade. In order to be filled on that low tick limit order you need to put your order in well ahead of time so that you're at the front of the queue. The same with the exit order.

The full range of the move has to be measured with perfection - to the tick. If you have a time stop then your estimate of time to target must be highly accurate.

The perfect trade does not take any heat - the trade does not even 1 tick against your position.

The perfect trade moves quickly in a favorable direction and does not waiver on its way to your target.

How many times have you pulled off the perfect trade? How many times in your trading career do you expect to pull off the perfect trade?

I have never pulled off a perfect trade and I never expect to. So I'm not going to waste my time trying to chase perfection. I've decided to leave perfection to those studying brain surgery.

If not perfect, then what?

You don't have to capture the full 100% of the move and you don't have to have a 100% win ratio to be a successful and profitable trader.

If you have a 50% win ratio and only capture 40% of the move then this can still be a winning approach if the strategy probabilities and stops are correctly calculated. An example would be a strategy which used a 2 point stop and 4 point target where the average move in the strategy was 10 points. This gives you an average net profit of 2 points for every two trades, or 1 point per trade. (Why wouldn't you go for the average target of 10 points in this strategy? Well the average may be skewed by the odd massive move of (say) 100 points and so a 4 point target may turn out to be optimal.)

As another example, a trader with a 10% win ratio can still be fantastically successful. Say this trader uses a 15 point target and a 1 point stop but consistently gets 1 winner out of each 10 trades. This means that every 10 trades he makes 15 points and loses 9 points. This is an average of 6 points per 10 trades or 0.6 points per trade. The problem with traders using this type of strategy is that it is psychologically very difficult to do. Say your strategy gives you a signal twice a day, on average. This means that you see about 10 trades a week. So it is possible to go a whole week, even two or three, before you see a winning trade. Can you handle that? Very few traders can. That's why you never see trading systems advertised on the web with a 10% win ratio. They all claim 85, 90, and 95% win ratios. Those strategies are easy to create. Just have a strategy with a 1 tick target and a 100 tick stop loss and you can use any entry signal and get win ratios like that. Of course the system would lose a lot of money but you could sell it on the internet and advertise win ratios of 95%.

So what's the deal?

Don't strive for perfection. You're not a genius and you never used to ace every test at school ( I bet someone's going to post a comment that theydid ) so why are you expecting yourself to ace every trade? Consider each trade a test on your way to earning your Bachelor of Trading degree. Once you have your Bachelors you can become an intern. This is when you're breaking even and your salary can sometimes cover your rent, gas and groceries, but often it doesn't. Your following years allow you to sit more tests and earn Honors, Masters and PhD's in your style of trading. Finally it was all worth while.

Were you thinking that you could walk into a position that advertised for PhD candidates only? Yes you can sometimes pull off tricks that beat the PhD's but over the long run they consistently beat you. You need to get there.

As usual I have wandered off track but I hope that I have give you some food for thought and you have learned something from this. Have you ever had a perfect or almost perfect trade?