The Prayer Cycle

Image via Wikipedia

H + W + P = E

I have combined these four letters to create a simple formula that is time tested and proven to make investors and traders wealthier.

The reason why this formula works is because everyone makes money trading. That is the easy part. In fact, if you ever have the opportunity to see the actual “hit rate” or frequency of being right verse wrong on trades, you would find that traders (regardless of experience or success) make money about 50% of the time.

In a game where the only three things that can occur is the market goes up, down or sideways, then it makes sense for 50% to be the natural win/loss ratio. * There are some trading strategies like quant and relative value that have higher hit rates; but that is a whole different ball game and not one I am going to address in this post.

So if traders, on average, are right only 50% of the time, meaning they make money 50% of the time and lose money 50% of the time, then how do some of them manage to be profitable?

The answer is that when they are right, they make more money than they lose when they are wrong. Framed another way, you could say that making money is actually the easy part (you are going to do it 50% of the time). The hard part is how to keep it.

That is why successful investing and trading is about losing less money or what we call Risk Management.

The way I have taught my clients to lose less money is by embracing the formula: