Reversing Trades

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I just wanted to discuss a slight trading myth. This being the notion that if you reverse a losing trading system you will win.

Unfortuunately this does not always work and is part of reason that trading is so difficult. You can have two traders trade opposite direction at the same time and both can come out losers.

The reason why you can’t reverse all trading systems is due to the risk to reward ratio and the need to manage risk If you have a positive risk to reward ratio, that is you risk more on one trade than you can win, then it is likely that you could reverse it.

Assmuing you risk 15pts to win 10pts and your results are:-

win loss loss win win loss loss win
10 -15 -15 10 10 -15 -15 10 Total = -20 pts depsite having a 50% win strike rate.

If you reverse the system you would be losing 10pts when you lose and winning 15 when you win. A total of +20pts. That is a 40pt difference between the two trading systems profit total. Quite a lot.

This shows why having a greater risk:reward ratio is not a great way to trade.

If you had a system that used a psoitive reward to risk ratio but it was still a lose (i.e had a very low strike rate) reversing a system could result in a loss also.

This is slightly harder to demostrate using numbers and would require not comparing identical strike rates. Think about it this way, if you were using 10 pts stops and 15 limits and opened a trade in both directions at the same price at the same time. The price could move up + 10 stopping out one trade and then move to -10 stopping out the other. Both trades lose.

I am sure there must be mathematical formula using the strike rate % and the reward to risk multiple that could show at what point reversing a trading system is profitable and at what strike rate either system becomes non-profitable and both break even, however I do not have the inclination to work it out. But I think you get the idea.

I will however be on the look out to see if anyone else has discussed this further as I think it has an important lesson to be learnt buried in it somewhere.

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