It is important that you know your stock trading system metrics, and you achieve this by conducting a systems research. You need to define your trading objective that is, know exactly what you want your trading methodology to attain. Now you have got a baseline you can use to check performance when you are trading in real time. Interpreting the results of your backtesting will 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 plan review you need to look at the key metrics. First of all, there is the win to loss ratio. This gives a good indication of tradability. It is the ratio of average winning trades taken against the average losing trades taken. However, you should realize that this is not the whole story 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 would like to make sure that the average price of your winning trades is greater than the average price of your losing ones. Expectancy defines a return in dollar terms for every dollar that you risk. If your system has an outlook of +0.80, roughly you could expect to make 0.80 times that amount chanced in the trade.
The maximum consecutive losses is another important 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 the 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 important consideration, because, let’s be honest, we’re all in the game of trading to make money. Nevertheless, it isn’t the only consideration and must be balanced with the other measures. As an example, if your drawdown is too great, you may not be well placed to live with the idea of losing your entire float. All these factors must be given due weight.
It is not easy to calculate all of these metrics, but thankfully, your backtesting software will most likely be able to calculate everything you need for your trading plan. The metrics will give you rules by which to trade, but you must also continue to monitor your system and compare real-time statistics with backtested 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.