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Saturday, November 05, 2005

Trading vs. Baseball: comparing batting averages

I have heard comparisons of baseball players and traders many times over the years. It usually goes something like this:

"A batter is considered [really] good if he only gets a hit 3 out of every 10 times at bat. So, when you look at your winners and losers, you are doing great if you have a 50/50 win rate."

There is one glowing flaw in this logic - a batter does not lose money on those other seven at bats. In fact, if he is a consistent .300 batter, he will probably get a nice contract extension! (Derrek Lee with the Cubs had the best batting average in 2005 - .335)

I am not here to dismiss or minimize proper money management. Many traders out there say they make a lot of money with a 50/50 win rate and proper money management. More power to them. But I think that many traders also use this logic as a crutch that prevents them from refining their skill so they ultimately have more winners than losers.

The question I am asked most often is, "What is your win rate?". My win rate is consistently 70-80%, and I am always striving to make it 80% plus. How? Look at the charts on this blog. I work hard to understand:

1.) price action - what is going on with the stock, not just in a single-bar set-up;
2.) support and resistance - where is it in relation to my entry and my exit;
3.) my target - where should I exit, and I should know that BEFORE I enter;
4.) the dynamics and meaning of bars (individually and as a whole) - is it a strong/weak candle, is it narrow range, how does it compare to the bars before it (the big picture).

As I said a few days ago - when I do have a loser, 90% of the time it is because I tried to force a trade - meaning a signal was not perfect, I anticipated and jumped in early, or I tried to invent a new set-up on the fly. The more I work on not "forcing trades", the better I will become.

The bottom-line is that I have a mental defect that will not allow me to accept more losers than winners. It has driven me to constantly improve. And, I have always refused to believe in the crutch of 50/50, or comparing my trading to a baseball player's batting average.

I posted this last month, but it is worth repeating:
IMO, the job of a trader is to wade through all of the set-ups presented to him every day and discard the bad and mediocre ones...if you do this, you will be left with only the [very] good set-ups and trading will be a lot easier and a lot more rewarding.

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