Winning more trades isn't the real key to trading profits

Imagine someone approaches you and says their winning trades outnumber their losing trades. You'd probably assume that person is doing well financially. It seems perfectly logical, doesn't it? If most of your trades are correct, the natural expectation is to be in profit.

Yet a higher number of winners does not by itself translate into profits. That may sound confusing, and it points to the connection between win rate and risk/reward.

When wins outnumber losses, your win rate sits above 50%. It could be somewhere around 60%, or possibly as high as 80%. Even so, a high win rate does not automatically make you a profitable trader. What matters more is how much you earn on winning trades compared with how much you lose on trades that go wrong.

To make this easier to grasp, let's return to the apple store example from earlier educational posts — yes, I really do like apples.

Imagine buying apples from a supplier and selling them to customers, hoping for a decent profit. Say you make money on 6 out of every 10 apple sales. That is a 60% win rate. It sounds quite good, doesn't it? But here is the problem.

Suppose each successful sale earns $3. When business turns bad and apples have to be sold at a discount, each losing sale costs $6. After 10 sales, the numbers look like this:

• 6 winning sales × $3 = $18 in profit
• 4 losing sales × $6 = $24 in losses
• Total from all sales = $6 loss

That hurts. You are right more often than you are wrong, but you still end up losing money. That is not exactly a formula for a successful business. So what was the real problem?

In trading terms, this is where the risk/reward ratio becomes relevant. Simply put, it compares how much money you risk on a trade with how much you hope to gain.

Back to the apple store: you were risking $6 in order to make $3. That is a risk/reward ratio of 1:0.5. What if the numbers were flipped?

Say you still make money on 6 of every 10 apple sales, but this time a winning sale brings $6 and a losing sale costs $3. After another 10 sales, the figures would look like this:

• 6 winning sales × $6 = $36 in profit
• 4 losing sales × $3 = $12 in losses
• Total from all sales = $24 profit

The win rate is identical, but the outcome changes completely.

Of course, real trading is not nearly that straightforward. Many other factors come into play, and you cannot simply choose to make bigger gains and take smaller losses every time. Markets do not always behave as expected, which can affect your conviction and also where you set stops and profit targets.

If there is one lesson to take from this, it is that winning as many trades as possible is not necessarily what matters most. Balancing your win rate against the actual amount made or lost on each trade may be the more vital skill for a trader.

Let's be honest. I would rather have a lower win rate and remain profitable than be right more often and let losing trades wipe out my money.