As I’ve mentioned before, trading, as a business, is unique in that you can test your business before you ever risk a cent. You can gain a complete and intricate understanding of how your trade system works. Through testing, you will discover how even a slight change in your system’s variables can have dramatic effect. And the more you play around with these variables, the more you will come to understand the relationships between them.
An example of this can be seen in the relationship between risk and reward. Systems that tend to have higher returns also tend to have larger drawdowns (risk). In the past, I have designed systems that return up to 300% p.a. but they have drawdowns of over 100% – that is to say, you’re guaranteed to lose your entire float and some when trading this system. In short, the greater the reward, the greater the risk.
With this in mind the astute reader may have realised profitability isn’t the only criterion by which you should be evaluating a trading system.
Here are a few other questions you should be asking:
* What percentage of wins are you achieving against the percentage of losses?
* What is the average value of your wins compared with the average value of your losses?
* How much money can your system make, on average, for every dollar that you risk?
* How many losses in a row does your system generate?
* What is your system’s maximum drawdown?
* How many trades does your system generate?
* And, of course, how profitable is your system?
To fully answer these, and other similar questions, you must analyse the results from your back testing. Unfortunately, with the overabundance of trading statistics which most back testing programs provide, this can be easier said than done. Let’s take a closer look at the key metrics you need to pay close attention to.
7 Metrics You Cannot Ignore When Analysing Your Trading System:
1. Win-to-loss ratio
2. Average wins and losses
4. Maximum consecutive losses
5. Maximum drawdown
6. Number of trades
These are merely the bare bones however. They form a simple checklist you should certainly apply to your trade system. To see the importance of these indicators in extensive detail please see the second part of this article which has a breakdown of each factor.