1.When you are taking a look at the performance of a particular system, first off you need to take a look at the win-to-loss ratio, as this is a good indicator of it’s tradability. Essentially this is the how many times on average the trade wins in contrasts to it’s losses. If you are winning more than you are losing, then your trade system might just be sound.
However, do not become reliant or caught up in statistics, because statistics do not tell you everything that is happening. It definitely does not take into account how large your winnings are in contrast to your losses.
2. Average wins and losses In addition to the win-to-loss ratio, you will want to make sure that the average value of your winning trades is greater than the average value of your losing ones. Say your back testing consisted of 200 trades. If 150 are losing trades and only 50 are winning trades, obviously your win-to-loss ratio is 25:75. But that on its own isn’t enough to determine if a system is good or bad.
Understand that, if the average of your wins were, for example, $2000 and the average of your losses were $500, you are still coming out on top ((50×2000)-(150×500)=$25,000).
3.The expectancy of a trading system is very important. In fact it might be the most important part, as it is the way of quantifying a system’s performance, which is independent of the trading float size.
Basically what this does is produce the projected return for every dollar you put into that particular trading system. This is a bit different from the reward-to-risk ratio that was mentioned earlier, because this shows a return for every dollar that you put in. If perhaps your system would have an expectancy of +0.75, you would get about 0.75 times that amount. Therefore if you risk a dollar, then you would likely make seventy five cents per trade.
In essence, if you are able to get an expectancy of $0.60, then you have a sound strategy.
4.Take a look at your testing results and determine how many consecutive losses your system has experienced whilst remaining profitable. You need to know this simply because the statistic will boost your confidence during times when you think you need to quit.
Imagine that you have experienced five to six losses in one day. If you don’t know how your system works, and how many wins you’ve had, then you might think it’s all going down the tubes. In all honesty, your historical data might say that you’ve experienced ten losses but are still generating profit.
5.The next thing to worry about is the maximum drawdown. This is the wost performance of your system at a given time.
This is a statistic that calculates itself, and you need to figure out whether or not you’re comfortable with the size of the losses that are accumulating. If you aren’t comfortable, then it would be a good idea to make some changes to your system.
This all comes back to the risk to reward ration. Bigger risks mean bigger payoffs. Of course, there was a system that I used once that returned a 140% p.a. That’s great, except for the fact that it’s maximum drawdown was 80%. Could you live with that? In the end it’s your choice.
Be at peace with the system that you are trading with.
6.Another thing that you have to deal with is the number of trades which a system provides throughout the year. This is one statistic that is not talked about nearly as much as it should be.
The trading system that you use must not provide too many or too few trades. The actual amount of trades which your trading system provides must be about the same that you can take, realistically speaking.
There are two sides to this, and both of them are fairly dangerous. When a system provides too many trades, the you need to choose between the signals, and this adds an element of ambiguity. With the ambiguity, you have human discretion, which may or may not be correct.
Then again, if a system provides trades in a smaller quantity, then you will not be taking full advantage of your trading capital, or the the trading opportunities that are presently available.
That said, how do you calculate the best number of trades for a given trading system?
Such is done by utilizing the what is known as ‘opportunity’. This is something that will help to determine the optimal opportunity in a system.
7. Profitability is just the return on your investment over the course of a year.
In the end, we’re all just trying to make some money, and the only important thing is the profitability. Though it’s very important, make sure that you balance it with the other six points regarding you stock trading system that I mentioned.
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