Evaluating Your Strategy – Ratios

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In a previous article we talked about how to know if your trading strategy was working, and at one point we mentioned that math was involved. Well, that’s what this article is about: how to calculate the relative success of a strategy, depending on different factors.

How you define “success” in trading is going to be based primarily on your own trading strategy and goals. Some tools can help you make that evaluation, and how you use them will depend on your trading objectives.

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The basics

As mentioned in the last article about backtesting, you want to accumulate as much data points as you can. No statistical analysis is going to be useful without good data.

Whether you are doing these calculations on the basis of backtesting or from your daily record of trading, the more data you collect, the more capable the estimates are going to be.

Of course, there is no way to guarantee that future performance will be in line with past performance, however, looking at historical trends is the best tool we have as traders to try and figure out where things are going.

Frequency: You need to know how often you are getting in the market. How many trades per day, or week, or month, depending on your regular trading habit.

Each time you trade, that’s a point of risk that you are taking in the market; the more points, the more likely you are to either make or lose money.

Therefore, knowing your frequency is an essential part of evaluating your trading. This is relatively simple to calculate: add up the total number of trades you’ve made, divide it by the unit of time you’re evaluating your strategy on. For example:

Total trades/days of trading = daily trading frequency.

Profit loss ratio: This is the number of trades that you take, and how frequently they work out. Again, as many data points as possible:

Total profitable trades / total losing trades = profit loss ratio

If the number is over 1, then it means you have more profitable than non-profitable trades. If the number is less than 1, then you have more losing trades – far from an ideal situation, but depending on circumstances, it can be managed.

Profitable trade percentage: A variant of the above, to know what percentage of your trades are profitable:

100 x Total profitable trades/total trades = % of trades that are profitable.

Effective profit loss ratio: This is how much you make on your profits compared to your loss. This is a more accurate understanding of how well your trading is going:

Total pips gained / total pips lost = effective PL ratio.

If this number is less than 1, then you are losing money (assuming you are consistent in trade size).

If you multiply the frequency of your trading times the effective PL ratio, you can determine how many pips you average per trading session:

Effective PL ratio x trading frequency = profitability per trading period.

By keeping track of these ratios over time, say, in a spreadsheet that you can convert into graphs, it should help analyze how your trading is performing in that period. This might give you some helpful insight into any counterintuitive phenomena that happen when trading, as well as inform you about how to organize your money management.

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