In this lesson
- get to know three basic types of strategies
- understand how their win rates and profit sizes differ
- find out why each of them will disappoint you one day
There are thousands of strategies, but most belong to a few families. Each family has its "character": how often it wins, how big its profits and losses are and in which market regime it thrives. When you know the character, its usual behaviour will not scare you.
Trend following#
Idea: what rises will keep rising – until the trend ends. Example: hold as long as the price is above a long moving average.
A trend-following strategy has a strange character: most trades end with a small loss, because a trend often fails to take off. The money is made by a few big trends that pay for all those small losses. In the example test from module 3 only 31% of trades were profitable – and yet the result was positive thanks to a few huge rallies.
- Thrives: in strong trends.
- Suffers: in a range, where it gives one false signal after another.
- Psychologically: hard – long streaks of small losses and waiting for the big trend.
Mean reversion#
Idea: a price that has moved too far from its average will return to it. Example: buy when RSI falls below 30 in a range, sell around the middle of the range.
A mean-reversion strategy is the mirror of trend following: it wins often, but little. Then comes a market that does not return – a fall that keeps going – and one big loss wipes out months of small profits.
- Thrives: in a calm range.
- Suffers: in a strong trend and in a crash ("cheap" gets cheaper).
- Psychologically: pleasant – until that one big loss arrives. Without a stop-loss it is outright dangerous.
Breakouts#
Idea: when the price breaks out of a range or a long-term high, it often keeps going. Example: buy when the day closes above the highest high of the last 20 days.
Breakouts are related to trend following: they catch the start of a move, but many breakouts are false. The win rate tends to be low, and the result comes from the breakouts that really take off – like November 2024 above 73,800.
Character in numbers#
| Type | Win rate | Profits vs losses | Worst regime |
|---|---|---|---|
| Trend following | low | big profits, small losses | range |
| Mean reversion | high | small profits, an occasional big loss | strong trend, crash |
| Breakouts | low | big profits, many small losses | range with false breakouts |
Every strategy has its bad period
No type of strategy works in all regimes. Anyone expecting a strategy without long losing periods is expecting something that does not exist – and will then abandon a good strategy right at its bottom.
Common myths#
- "I want a strategy that wins 80% of trades." Such strategies often lose everything at once every now and then.
- "Five losses in a row, the strategy does not work." For trend following that is a normal day at the office.
- "I will combine all three types and it will always work." Combinations have a character too.
Summary
- Trend following: low win rate, big profits, suffers in a range.
- Mean reversion: high win rate, small profits, an occasional big loss, suffers in trends and crashes.
- Breakouts: catch the start of a move, but many are false.
- Knowing a strategy's character means not giving up on it in its normal bad period.