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2024/10
Why Are Low Win-Rate Trading Systems More Successful Than High Win-Rate Systems ?
The success of low win-rate trading systems lies in their antifragility, which allows them to control losses effectively while taking advantage of high-reward opportunities in the market.
In essence, low win-rate systems thrive by taking small losses with a high reward ratio, whereas high win-rate systems often rely on wider stop-losses, which, when hit, can lead to larger losses.
Example of Kelly Formula Application
Consider two trading systems:
- System A with a win rate of 0.1 and a payout ratio of 30. According to the Kelly formula, the optimal bet size is 7% of the total capital: (30×0.1−0.9)/30=0.07(30×0.1−0.9)/30=0.07.
- System B has a win rate of 0.8 and a payout ratio of 0.5, with an optimal bet size of 40% of the total capital: (0.8×0.5−0.2)/0.5=0.4(0.8×0.5−0.2)/0.5=0.4.
Assuming each system follows a fixed win/loss pattern (System A wins once in every 10 trades, and System B wins four out of five trades), the long-term growth rate of System A is slightly higher. However, its drawdowns are more significant. This highlights a critical difference: while gambling systems rely on fixed win rates, actual trading environments involve variable win rates and payout ratios.
Antifragility in Low Win-Rate Systems
Low win-rate systems are typically more resilient to extreme market events, as they maintain short stop-losses and are better prepared for high-reward situations. They do not depend solely on historical patterns for protection, allowing them to profit from “black swan” events. In contrast, high win-rate systems may experience greater losses under the same circumstances due to their reliance on broader stop-losses, which are often based on historical market data.
Importance of Drawdown Control and Its Challenges
Controlling drawdowns is essential for long-term growth but challenging in practical trading, where emotional factors, market unpredictability, and other unquantifiable elements come into play. As drawdowns increase, traders often risk falling into irrational trading behavior, exacerbating losses. Effective traders recognize when they are trading emotionally and immediately halt trading to regain control.
Real-World Analogy: Biological and Economic Systems
Examples of antifragility abound in nature, such as genetic competition or venture capital strategies that limit losses while pursuing unlimited gains. This approach allows systems to thrive amidst unpredictability, unlike rigid systems that fail to adapt. In financial markets, maintaining flexibility and respecting natural market rhythms—rather than forcing control—enables long-term success.
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