How to Tell if Someone is Lying About Their Trading

I listen to scores of trading podcasts every week and here is one quick way to tell if someone is lying about their trading.

“I trade with 1:1 risk-reward ratio and I win on 80% of my trades”

100% bullshit.

Let’s first define what we mean by trading. Trading is the act of frequently buying or selling financial instruments in capital markets for the purpose of speculative gain. Let’s for the sake of argument say that a trader makes 2 trades per day. (The average is somewhere between 10-20 per day, but let’s indulge this claim made on podcasts all the time)

Ok, so I have a 10,000 account. We’ll trade at 10:1 lever for 15 pips target 15 pips stop twice per day. (This is actually the example I heard the other day on a podcast, so I am even making this up).

There are 250 trading days in a year.
I make 500 trades.
At 80% win rate I make 45,000 by year one.
Rinse and repeat.
By year two I now have $280,000 in my account.
By year three my account has swollen to $1,120,000.

In three years I have increased my account by 10X. Give me a decade and I will own the world.

Now let me explain why such claims are total bullshit.

Every trading strategy has something called the winning edge. It’s easy to calculate. The winning edge is basically the percentage difference between your win rate and your break-even point.

For example, if you traded with a 1:2 risk-reward ratio (risking 2 to make 1) your breakeven would be about 67%. If you won 70% of your trades your winning edge would be 3%.

Some points of reference. In blackjack casino edge is about 2%. In roulette, the edge is somewhere between 2-4%. Renaissance Technologies, the world’s most famous and longest-running quant fund has a winning edge of about 2% on the millions of trades it takes. Virtu and Citadel -- the biggest HFT market makers in the world -- are similar.

So, when someone on a podcast tells you they win 80% of their 1:1 risk trades that means they are claiming a 30% winning edge. (80% -- 50% breakeven rate).

They. Are. F-ing. Lying.

The reason why I get so upset about this is that it does a terrible disservice to many new traders who are trying to succeed at this game. It’s a Bernie Madoff type of hustle precisely because it seems so reasonable and attainable. Remember, Madoff ran his Ponzi scheme by being modest. He didn’t claim multi-hundred percent returns. He simply claimed a steady 1% gain every single month. His hustle was so toxic because it was so believable. Same with every BS artist on the web who claims they “rarely lose on their trades”.

Real trading is about losing all the time, every day. It’s about clawing out a 3% edge and trying to keep it for as long as you can.

Just for fun, I decided to take a look at the winning edge of someone who trades for real -- my partner Kathy. K has been on a blazing hot streak for the past six months putting up positive results 3 out of every 4 weeks while banking 1800+ pips in the process. Kathy basically trades with a 2.5:1 risk-reward ratio (these figures are rough estimates because she often cuts losers quickly but I was being specifically harsh in my estimates) for a 72% breakeven rate. Her win rate, however, is about 77% so she has been able to maintain a 5% winning edge for the better part of 2019. That may not sound glamorous but that was enough to produce one of the best streaks in FX over the past six months.

So don’t be fooled. Trading is a game of inches. Its rewards build over time but they are rich in experience and knowledge. So anchor your expectations properly, please.

Also, the next time you see a trader on Youtube and he is driving a Tesla -- then for SURE he is lying.

* This article was originally published here