Does a 95% Win Rate Result in Net Profitability?

Earlier, I discussed Win Rate as a factor of Fixed Stop-Loss and Fixed Profit Targets, and I showed how it was easily possible to achieve a 95% win rate… but now it’s time to see if these outcomes lead to net system profitability.

Please refer to the earlier post for the full descriptions and parameters of the study, but here is a summary:

DIA daily chart from 1998 to present
Momentum Long Entry:  Buys when indicator momentum crosses zero and stays above for one bar
MACD Cross: Buys when MACD Line crosses above the Signal Line
20 MA Cross: Buys when price closes above, after crossing above a 20 period SMA
TradeStation and Excel

I specifically asked you if a system which clearly generated a 95% win ratio (meaning when you play for a target of $1 while using a stop-loss of $20) yields a net profit.  Thank you for those who responded with your thoughts.  Let’s see the answers now:

Fact:  I assume TradeStation commissions in the calculation, which means for every 100 shares, a round-trip commission would be $2.00 and I also assume $2.00 slippage just to be safe and to mirror real-life execution.  This means that $4.00 was eliminated from all trades (a $100 profit would actually be recorded as a $96 profit while a $100 loss would actually be recorded as a $104 loss in terms of the net profitability calculation).

All trades are fixed at 100 shares, meaning a $1.00 profit in the DIA would result in a profit of $100 per trade.

Let’s refresh (Win Rate or % profitable with a $1 target and $20 stop):

Momentum:      96.50% (115 trades)
MACD:             95.08% (61 trades)
20-MA Cross:   94.73% (76 trades)

On to the results:

Playing for $1.00 ($100) while risking $20 ($2,000) per trade does yield a 95% win rate for all three systems I tested, but here are the results of Net Profitability (dollars gained) by the 10 year strategy trading 100 shares:

Momentum:      $2,591 (115 trades, 4 losers)
MACD:             $33 (61 trades, 3 losers)
20-MA Cross:   -$150 (76 trades, 4 losers)

Let’s take the pure results and add back $4 per trade to see what would have happened before commissions and slippage per trade:

Momentum:      $3,051 (115 trades, giving back $460)
MACD:             $277 (61 trades, giving back $244)
20-MA Cross:   $154 (76 trades giving back $304)

Congratulations to reader Cedric who provided us a formula who most accurately estimated the results.  His comment read:

Isn’t it just:
(Win %) * (Profit Target) – (100% – Win %) * (Stop)

So for the $6/$2 with the Momentum (roundest numbers):
0.26 * 6 – (1 – 0.26) * 2 = 0.08 (Net Profitable)

A tiny edge, but an edge nonetheless. Although most brokerages would eat that tiny edge up in fees.

Wes was also right with the logic :

If you risk $20 to make $1 then with a win rate of 95%, out of 100 trades you will lose 5 times for a loss of $100 and you will win 95 times for a gain of $95. I guess you can go broke being right.

By the way, the DIA was near $70 at the start of the 10 year period and ended recently near $125, for an increase of $55, meaning if you had bought and held 100 shares of the DIA when these three test periods started, you would have ended near $5,500.

The Momentum study, with the highest win rate and net profitability rate, achieved half that total, despite taking 115 trades and achieving a 96.5% win rate.  The Momentum study actually experienced 4 losing trades.  With the other two strategies, you roughly broke even, net of fees.

I’ll continue to address this topic, and will provide the Excel charts for Net Profit and other factors relating to the tests, including number of trades, average trade size, average bars (days) in a trade, etc.