It is imperative that you know your stock trading system metrics, and you achieve this by conducting a systems analysis. You need to define your trading objective – that is, know what you want your trading system to achieve. Now you have a baseline you can use to check performance when you are trading in real time. Interpreting the results of your backtesting can help you make any informed system tweaks.
Profitability is not the only criterion by which you should judge a trading system. When you conduct a trading plot review you need to look at the key metrics. First of all there is the win to loss ratio. This gives a excellent indication of tradability. It is the ratio of average winning trades taken against the average losing trades taken. But, you should realize that this is not the whole tale, because it does not consider the size of the winning trades versus the size of the losing trades.
The average cost of your losses and wins is another significant metric to grasp. You wish to ensure that the average cost of your winning trades is larger than the average value of your losing ones. Outlook defines a return in dollar terms for every dollar that you risk. If your system has an expectancy of +0.80, on average you might expect to make 0.80 times that amount hazarded in the trade.
The maximum consecutive losses is another vital metric. From your backtesting, you have to know how many losses in a row your system sustained while still being profitable. A knowledge of this can give you confidence to ride out a string of losses which you will encounter at some particular point in your trading. The maximum drawdown is another thing to be considered. You want to judge if you are ok with the dimensions of loss your best trading system allows for.
The number of trades is simply the number of trades a system gives over the course of a year. Your system should not give too many or too few trades. If there are too many, you will be forced to choose between signals which will add to the ambiguity of your system and ultimately make it far less effective. If there are too few trades given, your capital will be underutilized.
The profitability of your system is your return on investment over a year. This is an vital consideration, because, let’s be honest, we are all in the game of trading to make money. But, it is not the only consideration and needs to be balanced with the other measures. For instance, if your drawdown is too fantastic, you may not be able to live with the thought of losing your entire float. All these factors must be given due weight.
It is not straightforward to calculate all these metrics, but thankfully, your backtesting software will probably be in a position to calculate everything you need for your trading plot. The metrics will give you rules by which to trade, but you must also continue to monitor your system and compare real time statistical data with back tested results.
These metrics are invaluable and a stock trading system review is imperative. Once you do such a review, the informed tweaks to your trading system will indisputably produce a far more worthwhile trading system.
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