Stock Market Wizard, U.S. Investing Champion Mark Minervini Shares Ideas and Wisdom Here FREE!
June 09, 2014
I have always lived by the following philosophy: expect the best and plan for the worst. Systems that rely on a high percentage of profitable trades never impressed me very much; they expect the best and plan for the best. I always felt that they were too risky if something went wrong and they lost their edge. The end result may be the same during periods when things are going along normally. However, if a trader has to be right on 70 or 80 percent of his trades and that’s his edge, what happens if he’s right only 40 or 50 percent of the time during a difficult period? What about during a really difficult period?
The problem with relying on a high percentage of profitable trades is that no adjustment can be made; you can’t control the number of wins and losses. What you can control is your stop loss; you can tighten it up as your gains get squeezed during difficult periods. I like to keep my risk/reward ratio intact so that I can have a relatively low batting average and still not get into serious trouble. It’s a concept that I call building in failure.
My goal is to maintain at least a 2:1 win/loss ratio with an absolute maximum stop loss of no more than10 percent. I shoot for 3:1, and I’m elated if I can attain this ratio with even a 50 percent batting average. This means I’m making money three times faster on my wins than I’m losing when I’m wrong. At a 2:1 ratio, I can be right only one-third of the time and still not get into real trouble. At a 3:1 ratio, even a 40 percent batting average could yield a fortune. If I’m able to be profitable with such a low percentage of winning trades, I’ve built a lot of failure into the system.
Excerpt from Trade Like A Stock Market Wizard by Mark Minervini (McGraw Hill Publishing –2012)