What the…?! I know, that was surely your immediate response to this headline, right? If you never heard of the “CoinFlip Trading Experiment”, then you should stay for the next few minutes.
Why? Simple: You will now learn a lot about the importance of exiting a trade and how the basic trade management principles look like.
Moreover, I’ll show you a powerful entry strategy to get the most out of your risk-taking.
Let’s dive right in …
About the Experiment
Inspired by trading coach Van K. Tharp, the so-called Coin-Flip Experiment was conducted a few years ago by myself to test the influence of trade management on the P/L after initiating a position.
Before, I had heard a lot of the importance to exit a trade smartly. Van cited in his books that a good exit is able to compensate for a poor entry. In principle, his opinion was, that every entry strategy could play out well in the end when the trader uses a proven exit plan. But I didn’t find any reliable tests on that out there.
At some point it grabbed me, and I decided to test it myself. That was because at this time I struggled with trading and was searching for a confidence boost.
I set the goal to test a random entry setup for the timespan of 250 trading days (one year). If a random entry isn’t a bad entry, then what?
What I tested
Here are the basic conditions of the CoinFlip Experiment:
Number of trades: 250
Market: Eurex Bunds (German ten-year bonds)
Time of entry: 8:30 am CET (only one trade per day)
Risk-Management: A maximum risk per trade of 2% when the account goes up but minimum lot size always remains two contracts.
Account: 20k demo
The coinflip trade had to be finished intraday (22 pm CET). I didn’t use a flexible lot size algo because I wanted to test the direct impact of the trade management on the P/L.
Every Sunday I announced the coin flip results for the trades of the upcoming week on my CoinFlip Trading Blog. Cheating impossible! Indeed, I flipped the coin by hand. Head for a long, number for short. That was really kind of fun.
At this point, you know everything you need about that unmatched live test in trading history. The course of the experiment was fascinating. Therefore. stay tuned …
At the beginning of the experiment, my hope was to trade better than break even. This was my benchmark for the 250 trades.
After 15 weeks of trading, the account was up around 40 percent. Over the next 25 weeks, the performance wasn’t as good as before but my account was growing steadily (around 10%), and not one weekly low in the performance was broken to the downside.
But the test ran for another 10 weeks and indeed the result went up again. When I checked my account after week 52, I saw a stunning result of 83,16% net win.
To be honest, I’d never expected that. Ever!
But I need to put in three notes here:
- At the time the experiment was running, the Bund-Future was very volatile (euro crisis). Moves of over 100 ticks up to 200 ticks within a day were standard.
- Maybe you already realized it, but the entry wasn’t 100 percent random. The direction was random but the time of opening the position was not. And I chose the time of initiating the trade for a good reason. More on that later.
- The Bund-Future is one of the markets with a damn good effort benefit ratio. Means: In relation to the win per tick amount the round turn costs you pretty little.
I’m sure that all of these points helped to succeed gloriously.
Here are some more interesting numbers my trading journal spat out regarding the test:
- The profit factor over the course of the test was 1,67.
- The actual win-to-loss ratio (amount of wins vs the number of losses in EUR) was 1,97.
- The hit rate of the strategy came in at 46%.
As you can see, those numbers weren’t too impressive, but keep in mind I had no clue whether the next trade was long or short and the only instrument to affect the outcome was my proven exit strategy along with intensive market experience.
Ok, let’s go to the next step and try to figure out what you can learn from this experiment to improve your own trading.
The learnings from trading with a coin flip
Main takeaways for your exit
The main thing with the exit you should know is that good trade management is able to compensate for a bad entry but never the other way around. The exit decides whether your trade is going to be a winner or not.
Now the time has come to hand over the four principles I used to get through the 250 coin flip trades:
- Use a stop-loss which reflects the volatility of the current market conditions.
- As long as your trade alternates around its entry price after initiating the position, give additional time to evolve.
- If the trade is stuck in the mud for another period of time, start decreasing your risk exposure. You can do this by trailing the stop loss when it makes sense or by throwing out half the position (I recommend doing so when the trade is in red territory only).
- Whenever the trade significantly runs into green P/L, you need to protect your gains or at least part of it.
Tip: From my experience, when you trade intraday, it’s worth it to work with take profits orders. The closet the price gets to your target area the more aggressive you need to be when safeguarding your gains.
Note: There is no holy grail rule for this strategy and in some cases, you won’t do it perfectly. But luckily you don’t need to be an exit hero all the time. As a trader, in the end, it all depends on your ability and discipline when it comes to applying the right principles.
Main takeaways for your entry
As a reminder: With only 46% hit rate, the result was more than an 83% return.
Therefore, you have to acknowledge the experiment makes it obvious that you don’t need to be right with more than half of your trading ideas. Do you agree? I hope so…
1. Risk to Reward
I know almost all traders at some point have been confronted with this phrase when it comes to profitable trading.
But there is one thing the vast majority of gurus don’t tell you when they talk about risk-reward. Namely, there are two types of risk to reward:
- The risk to reward of a given trading idea
- The resilient risk to reward of a given trading idea
This subtle distinction is crucial to understand when you want to earn trading laurels.
So, what’s it all about?
As a trader, you are able to get every risk to reward ratio you wish for your trading idea. Just narrow your stop loss or choose a bigger take profit and there it is, your perfect risk to reward for the trade. If only it was that easy, huh?
But the truth is: Many traders exactly do this. Hazardous!
I hope you can see at which point this habit gets you in massive trouble
Sometimes, you underestimate what the risk to reward of a trade really is and therefore you choose to quit a trade too early. But as from my experience, more often you overestimate the potential of your trading idea.
Both mistakes will cost you a whole bunch of money in the long run.
2. Your job with the entry
What you have to do as a trader is to master the skill of anticipating high potential risk to reward scenarios where the reward could be seen as truly resilient whilst using a given stop loss.
In more practical terms: A good risk to reward can be described as a big enough move in your favored direction, in at least 50% of the time, before the stop loss is triggered.
The question now is how do you figure out those scenarios?
Here is my best advice: Become an expert and only trade a few markets, maybe only one or two. It would be good to concentrate on one or two specific setups which you completely understand.
To constantly find resilient risk to reward trading ideas, let yourself be inspired by the CoinFlip Experiment.
Approaching the market during its opening phase is one proven way to lock in big moves with a calculated risk again and again.
When you make sure to only trade when the market just opened, then the main move of the current trading day – in most cases – hasn’t happened, yet. Bingo!
As you can see, you shouldn’t neglect the entry only because of the amazing result of the CoinFlip Experiment. A good entry helps you to step up the profit factor for sure. And now you should know, why.
Maybe you have to adjust your definition of a good entry a little, ok, but that shouldn’t be a problem for you.
To be clear: The higher your hit rate, the better. But the increment should not come at the cost of a much lower actually traded win to loss ratio.
3. Main takeaways for you risk management
Risk Management is huge and tied closely with trade management. That’s because the exit allows you to take risk off the table by kicking out contracts or stocks after the entry.
However, solid risk management regarding the pre-trade phase can be summarized in a short paragraph:
Don’t ever use a martingale position sizing algorithm when trading with leverage. Instead, do the opposite! Only increase your lot size when your trading account starts to rise. I used the same strategy with a good outcome. And, of course, always use a stop loss – and pull it – to protect your money, regardless of what you think the market is going to do next.
Finally, don’t risk more than 2% per trade of your account line when day trading, if you want your account to survive.
The CoinFlip Experiment shows in an impressive way that you don’t need to be in charge of the direction of a specific trade to succeed. It also suggests that if you are not capable of good trade management, you’re going to lose over the long haul, but when your entry is bad, you probably still can be profitable as long as you use well-chosen exits.
My belief and experience are that the best traders try to catch resilient risk to reward setups and work with the ongoing information the market gives to them after they have entered a position by adjusting their trade and risk-management accordingly.
As for you, do the opposite of what the masses do and master the exit before trying to improve your entry.
The guest post is contributed by Ingmar Folk, founder of CoinFlip Trading Consult. He has been trading professionally since 2005 but not full-time. As a trade, the author is specialized in exiting trades.