Last week we looked at key components of the daily session review process (If you missed it, refer to last weeks article Part 1 and Part 2). This week we’ll look at another key aspect of your review process – but longer term – some of the key stats you should monitor to measure the profitability of your trading business.
These stats should be monitored over a series of trades, at the very least nothing less than 20. So, it’s something you’ll want to schedule as a part of your longer term review processes, maybe weekly or monthly, depending on your frequency of trades.
So, what stats…
win% = number of winning trades / total number of trades in the sample
This is simply the percentage of winning trades. Nice and simple.
win loss size ratio = average win / average loss
This is a comparison between the size of your wins and the size of your losses. A ratio greater than 1 indicates that on average, your wins are greater than your losses. A ratio of less than 1 indicates that your wins are smaller than your losses. (Note: sometimes also called Profit Factor)
Expectancy = (Win% x Average Win) – (Loss% x Average Loss)
The expectancy formula provides a means of quantifying your edge over a series of trades. A trading strategy that makes money over the sample of trades, will have an expectancy greater than zero. A losing strategy will have a result less than zero.
You will notice that this expectancy formula is really just a mathematical manipulation of the previous two stats, win% and win loss size ratio. However, it’s worth tracking as it’s a simple indicator of profitability. Profitability cannot be determined from win% alone, or from win loss size ratio alone, as it’s a function of both. For example, it’s possible to have a profitable strategy with a very low win%, provided the win loss size ratio is high enough. It’s also possible to have a profitable strategy when average losses are much larger than average wins, provided win% is high enough. (please think about it first, but email me if you just don’t get this)
Note: you may come across other formulas for expectancy, but they’re all variations on the same formula, and all provide the same result – an objective means of quantifying your edge over a series of trades. For example…
It doesn’t matter if you use a variation – just make sure you measure expectancy somehow.
Recording and monitoring these three figures over time allows you the following benefits:
a means to confirm consistency of results and performance, when your expectancy, win% and win loss size ratio match your historical averages
a warning that something is wrong, when expectancy, win% and win loss size ratio vary from your historical averages.
And when something is going wrong, these figures may help point the way forward. For an example, refer to this previous article: http://yourtradingcoach.com/trading-process-and-strategy/improving-exits-win-loss-size-ratio/
Ok, simple so far…but here’s an additional step that I want you to consider…
To really provide you with greater benefit, I want you to consider tracking these stats for subsets of your trade data.
For example, do you trade best during the session open, mid-session, or session close? You’ll only know by tracking your expectancy, win% and win loss size ratio for trades in each of these three categories.
Does your performance vary based on the day of the week? Some people’s results do. The only way of knowing is by tracking your expectancy, win% and win loss size ratio for each day of the week.
Is the bulk of your profitability coming from only one or two of your setups, or is one of your setups perhaps grossly underperforming, leading to reductions in your overall expectancy? The only way of knowing is by tracking your expectancy, win% and win loss size ratio for each of your setups.
Which type of exit strategy is contributing the most to your overall profitability – those where you target a price, or those where you implement a trailing stop? The only way of knowing is to track your expectancy, win% and win loss size ratio for trades in both categories.
Don’t worry, this doesn’t need to be a whole lot of work, and you don’t need to do any calculations if you’re not comfortable with maths. There are some great spreadsheets available that do this for you.
The one I use, TJS Version 5, automatically works out these figures. And provides a feature that I haven’t seen in any other spreadsheet system – not only does it allow for tracking these stats in up to 6 different performance categories, but they’re also completely customizable.
I could track expectancy, win% and win loss size ratio based on how many coffee’s I’ve had before my trading session, if I wanted to. (Actually, that’s maybe not a bad idea!!)
Anyway, keep stats for expectancy, win% and win loss size ratio. Be sure to track them for any subsets of your trading session, which are relevant to your circumstances. And conduct regular reviews to monitor your performance.
And if you’re not into doing it all yourself, check out the TJS Trading Journal Spreadsheet.