What is the larger relationship between your stop-loss strategy and your profit target method?  I tested three strategies and evaluated the change in win rate – % Profitable Trades – across 400 tests per strategy and present the abbreviated results here.

First, let’s define the methods:

DIA Daily chart from Jan 1 1998 to May 29, 2008 for almost 10 years worth of data.
TradeStation custom strategies – optimized data imported into Excel Surface Charts.
Comparing the cross-tabulation of 400 studies (per examination) on the %Win Rate (profitable trades).
All strategies were ‘long only’ entry strategies.

First, let’s look at the Momentum Long Entry Strategy (buys when indicator “Momentum” crosses the 0 line and then price appreciates one day after this cross occurred).

Next, let’s examine the MACD Cross Strategy (buys the open of the next bar when the MACD line crosses above the exponential average signal line of the MACD):

Finally, let’s examine the 20 Period Simple Moving Average Price Cross Strategy (buys when price crosses above the 20 day simple moving averages and closes above it for one day).

Be sure to click each chart for the full-size image.

The relationship I discussed earlier is clear and makes logical sense.

The larger your stop, the greater your win rate.

The smaller your profit target, the greater your win rate.

In fact, in all three tests, you could achieve a 95% or better win rate if your stop-loss was $17 to $20 with a profit target of only $1.  This result held true in all three tests (with the Momentum test showing the most robust high win-rates).  The Momentum strategy actually showed a win-rate greater than 90% for any value above an $8 stop-loss (with a corresponding profit target of $1).

Keep in mind that using the DIA, $1.00 corresponds with 100 Dow Points.  This essentially means that with each entry, you play for 100 Dow points with a stop-loss 1,700 to 2,000 Dow Points away.

As expected, the win rate plunged to 6% across all tests with a Stop-Loss of $1 and a profit target of $20.

What was the % win rate of all strategies when the target was $1 and the stop was also $1?

Momentum:      51.5% (361 trades)
MACD:             46.22% (106 trades)
20-MA Cross:   54.3% (151 trades)

Let’s look at the classic “3 to 1″ reward to risk relationship (target = $3 with stop = $1)

Momentum:      29.38%  (211 trades)
MACD:             27.27% (99 trades)
20-MA Cross:   35.11% (131 trades)

How about the corresponding “3 to 1″ with looking at a target of $6 and a stop-loss of $2?

Momentum:      26.00% (100 trades)
MACD:             25.33% (75 trades)
20-MA Cross:   23.80% (84 trades)

And for fun, what about the ‘for-test-only’ value of a $1 profit target with a $20 stop?

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

Was the system net-profitable for the maximum values tested?  In other words, with a win-rate of 95% or better, what was the overall net-profit?

That’s to be discussed in a later post, but I wanted to pose the question:

What do you Think?

Do you think any (or all) of the strategies will yield net profitable results with such a high win-rate?

Stay tuned to find out!