Why a High Win Rate Can Still Lose Money: Payoff Ratios and Trade Expectancy
Win rate alone can hide a pattern of small gains and large losses. Calculate the break-even win rate using realized average wins, average losses, and trading costs.
Trading performance depends not only on how often you win but also on how much you gain when you win and lose when you lose. Here, the payoff ratio is defined as the average gain divided by the absolute amount of the average loss. Win rate and payoff ratio together can be used to calculate expected profit or loss per trade, but they do not guarantee future performance.
Distinguish target and realized payoff ratios
The ratio of target profit to planned loss at entry is a plan. In practice, selling part of a position before the target or receiving an unfavorable fill on a loss-cutting order can change realized average wins and losses. Counting partial trades as several separate wins also distorts the win rate. First define how to group trades arising from one investment decision, then maintain consistent rules for including break-even trades and unrealized gains and losses.
Account for costs separately in average profit and loss
Let p be the win rate counting only winning and losing trades and excluding break-even trades, W the average gain on winning trades, and L the absolute average loss on losing trades. Expected profit before costs is p×W−(1−p)×L. Subtract average cost per trade c to get expected profit after costs. If costs are already included in W and L, do not subtract them again. The break-even win rate is L÷(W+L) without costs, or (L+c)÷(W+L) when costs are counted separately. If break-even trades are included in the total trade count, the probability of a loss is not 1−p. In that case, use the proportions of winning and losing trades among all trades separately and consistently account for the costs of break-even trades as well.
Averages can hide losing streaks and small samples
Even with the same average profit per trade, consecutive losses can lead you to abandon the plan or exhaust the account's funds. Averaging trades of different sizes by count alone also conceals the account impact of large losses. Divide the trade sample into periods and check whether a few of the largest losses drive the overall result. A high win rate from a short bull market may reflect market conditions; do not claim that a few trades establish a stable probability.
If results look good only after excluding the single largest loss, check whether the strategy's structure could produce it again before dismissing it as an exception. Conversely, if performance is concentrated in one very large gain, win rate alone cannot explain its sustainability. Viewing profit and loss per trade in won alongside profit and loss relative to the initial risk budget helps separate the effect of changing trade sizes on the average. Start by avoiding the combination of data with different definitions.
Worked example
Hypothetical example: In a before-cost tally of winning and losing trades with no break-even trades, assume an average gain of KRW 200,000, an average loss of KRW 100,000, a 40% win rate, and a cost of KRW 10,000 per trade. Expected profit is 0.4×20−0.6×10−1=1 in units of KRW 10,000, or KRW 10,000. The payoff ratio is 2, and the break-even win rate including costs is 11÷30≈36.67%. By contrast, an 80% win rate, average gain of KRW 20,000, and average loss of KRW 120,000 give expected profit before costs of 1.6−2.4=−0.8 in units of KRW 10,000, or −KRW 8,000. The second pattern's higher win rate does not necessarily make it more attractive.
What to check
- Have you defined the numerator and denominator of the payoff ratio?
- Have you distinguished targets from gains and losses at actual execution prices?
- Have you avoided omitting or double-counting costs?
- Have you checked the impact of losing streaks and large trades?
Sources and primary materials
This is educational material about research methods. For an actual company decision, verify the filings and primary sources for the relevant period.