One of the fundamental points that you need to get to grips with when trading binary options is the win loss ratio of your strategy. Together with the risk to reward ratio, this will determine how successful and ultimately how profitable your strategy is.
The win loss ratio in binary options shows us the number of winning trades from the total number of trades that are taken for a given strategy. It is expressed as a percentage.
It is sometimes referred to as the strike rate. It takes on a particular importance when trading with binary options due to the fixed risk reward of the contracts used when trading.
It is a simple formula that can be calculated as follows:
- Total winning trades / Total trades * 100 = Win Loss Ratio %
- Example: 43 (winning trades) / 50 (total trades taken) x 100 = 86% win rate
Relationship With Risk to Reward
The risk to reward ratio in binary options is fixed, being determined by the percentage return that a broker is prepared to pay you for an s in the money contract. This is unlike many other forms of trading where you can determine your risk to reward on each individual trade.
For example, on the spot Forex market you choose where to place your targets and stops on each trade. These can be set to reflect the risk to reward that you are prepared to take.
It is true, that you can check different brokers to compare contracts in order to find the highest return. Or maybe you could focus on the higher risk to reward occasionally offered on some longer term contracts. However there is little you can do to significantly alter the risk to reward on most contracts.
As a result of this fixed return, the win to loss ratio of a strategy takes on particular importance. It provides one of the only ways in which you can significantly alter the overall performance of a strategy. With a fixed return, the more you can increase your win to loss ratio, the more profitable your trading will be.
As we saw in this post because most binary options contracts offer a risk to return ratio of less than 1, we need to have a win loss ratio in excess of 50% for a strategy to be profitable. A truer figure is around 56% . It should however be stressed that this is just a baseline and will not yield a profitable strategy. To make money on your account you will need a strike rate in excess of this figure.
The 70% Win Loss Ratio
It is no coincidence that many signal providers quote a 70% strike rate in their literature. This is often seen as a benchmark level that is needed for a strategy to register a worthwhile level of gains.
Let’s take an example using a typical contract return of 70% return which you will find offered by many brokers.
A strategy with a 60% win loss ratio yields the following level of performance, which ties in nicely with the suggested breakeven of around a 56% win rate -
- 6 win ($75*6) = $450
- 4 lose ($100*4) = $400
Return = +$50
Assuming a $1000 balance and 10% risked per trade this gives a real return of 5%.
Now let’s look what happens when we raise the win rate to 70%
- 7 win ($75*7) = $525
- 3 lose ($100*3) = $300
Return = +$225
Suddenly the return has jumped . We now have a real return of 22%, significantly higher (17.5%) than what was achieved at the 60% strike rate.
Using the same assumptions we can now look to see how the win loss ratio affects the profitability of a strategy higher up the scale.
|Win Loss Ratio||Return|
From these simple calculations it is clear how important this the win loss ratio is in relation to the profitability of a binary option strategy. We have of course made some assumptions.
The actual return earned on each contract will add variances to these figures. The greater return that you can earn on each binary options contract the higher the yield and therefore the more money you will make. However there is no escaping the fact that the win ratio is pivotal to the success or otherwise of a strategy.
The Optimal Win To Loss Ratio
From the above we know that a strategy based on 70% contract return will need a 56% win rate in order to keep parity. Above this level will generate a real return for the trader.
So if there an optimal win to loss ratio. Well clearly the aforementioned 70% is a good level to aim at. With a standard higher/ lower option contract yielding around 70-90% depending on the broker used, winning 7 trades out of 10 will see you achieve some good gains.
Of course don’t forget that it is also important to factor in some good money management rules for the strategy. Without these even a strategy that performs well can easily under-perform or be broken.
What it is crucial to understand is that the closer we can get the risk to reward ratio on each trade to 1 (or higher) and the higher the win rate that can be achieved for the strategy, the lower our binary options trading risk will be.