The size of profits of a trading system, is related to time and accuracy. They are inter-related and it is not possible to get the best out of all 3 factors in any trading system.
Before I elaborate further, I shall define what these 3 factors mean.
Size of profits – I am referring to the average amount of profits the system will earn per trade.
Time – The average length of time you held on to a trade.
Accuracy – The percentage that the system is correct and earns you a profit.
Big Profits = Long Time = Low Accuracy
For systems that aim for big profits, they must allow a greater range of fluctuations for the trade. By having a large trading range will in turn prevent you from getting stopped out so soon. Hence, you will be in a trade for a longer period of time. Besides having a larger profits, it will also serve you losses that are bigger, because your stop loss limit has to be further from your entry point. It is more difficult to grasp for the relationship with accuracy.
Small Profits = Short Time = High Accuracy
On the contrary, a highly accurate trading system allows you to be right most of the time but each time when you are right, you take very small profits. This is possible by making very tight stops in your trades such that you lock in profits as soon as you make them. Hence, you will be in and out of the trades very fast and frequently. This is typical to intraday trading or mean reversion models or even band trading. (more…)
