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I'm amazed at the number of performance numbers which mathematicians can
devise! As for me, inspection of a chart of the equity curve is the
determining factor. I want that "curve" to approximate a straight line as
closely as possible and to do so consistently and independently of the
changing trends in the market. This property is much more important than
the magnitude of the end result (provided, of course, that the line DOES
have an upward slope). If such a system shows a mediocre rise, I can boost
it simply by increasing the trade size, something I would NOT do if the
curve were erratic with occasional protracted loss periods.
Carroll Slemaker
----- Original Message -----
From: "John Hayden" <jhayden@xxxxxxx>
To: <omega-list@xxxxxxxxxx>
Sent: Wednesday, March 27, 2002 6:03 AM
Subject: Criteria for determing a "good" trading system Part 2
> part 2 continues
> ---------------------
>
> Once we know the amount of heat we can endure we must decide on how we
will
> measure the performance of the trading logic. Below is a list of the
> common, and not so common indicators. However, what determines what a
> "good" value is for these indicators will depend largely upon the traders
> answers to the above questions. Here is a summary list. The minimum
> performance levels are based on trading a 1 lot S&P on a 3 minute chart,
> and doesn't account for slippage or commissions (as this seems to be the
> standard practice):
>
> 1. Net Profit per Trade (Avg. $ per Trade) $ 200 minimum
> 2. Profit Factor (Gross Profit/Gross Loss) 2.0 minimum
> 3. Drawdown/Run-Up Analysis
> 4. Sharpe Ratio 4.0
minimum
> 5. Total Trades 2-6/day
max
> 6. Total number of Longs/Shorts Ratio ~1:1
> 7. Total Net Profit n.a. -
> subjective
> 8. Average Winning Trade
> 9. Average Losing Trade
> 10. Average Win To Average Loss Ratio Depends on %
winners
> 11. Largest Loosing Trade/Average Win Ratio 1.5 or lower
> 12. Largest Drawdown/Average Win Ratio 7.0 maximum
> 13. Average Drawdown/Average Win 1.0
Maximum
> 14. Percent of Winning Trades n.a. - subjective
> 15. Max. Consecutive Winning, & Loosing Trades n.a.
> 16. Average Number of Winning, and Loosing Trades
>
> Gross Profit per Trade (GPT)
>
> Calculation: Total Profits divided by Total Trades
>
> This number is perhaps the most important because it tells us the average
> profit we can expect to make on each trade. Each trade will generate two
> associated cost; slippage, and commissions. Should the GPT be low then
> slippage will change a profitable system to a loser. The higher this
number
> the better. It is important to realize that when commissions AND Slippage
> are factored in many systems fall apart because this number is not higher
> than actual cost. Generally this number should be twice the expected
amount
> of slippage - plus the commissions cost - for the S&P $200.
>
> Profit Factor
>
> Calculation: Total Profits divided by Total Loss
>
> This number will tell us the amount of profit we gain for every dollar
> placed at risk. Generally we want to risk $1 for the possibility to gain
at
> least $2 dollars.
>
> Drawdown Analysis - Consecutive Losing Periods
>
> 1. Determine the percentage of money lost (maximum)
> 2. Identify the length that it took to hit this maximum percentage loss.
> 3. Identify how long it took for the Recovery to take place.
> 4. The Peak is the time frame just before the drawdown began, or the Start
> Date (which is one time frame less).
> 5. The Valley is the time frame that the worst percentage loss was
experienced.
> 6. Identify the maximum amount of money lost.
> 7. If not using time to identify length of drawdown then determine the
> number of trades before the equity is restored.
>
> Run-Up Analysis - Consecutive Winning Periods
>
> 1. Determine the maximum percentage of money made in the Run-up.
> 2. Identify the Start date the winning streak began.
> 3. Identify the End date of the winning streak.
> 4. Identify the length of time that it took to hit this maximum percentage
> gain.
> 5. Identify the maximum amount of money gained.
> 6. If not using time to identify length of run-up then determine the
number
> of trades before the equity is begins to decrease.
>
> Generally we want to avoid any systems that experience more than a 30%
loss
> of capital. We must totally avoid systems that generate 50% or more of a
> drawdown as it becomes almost impossible to recover from such a large
> reduction in ones equity. In judging the length of a drawdown to endure it
> is generally best to look for a system where the total length of the
> longest drawdown is no more that twice as long as the total length of the
> largest run-up. This is a subjective rule and is totally dependent upon
the
> trader and the amount of pain he can take.
>
> Sharpe Ratio
>
> The ratio is based upon comparing the standard deviation of the system
> returns and the amount of risk of that system - to the amount of return
> that could have been earned in a risk free investment. Generally the
higher
> the Sharpe Ratio the better the system. The Sharpe Ratio is a good way to
> compare different strategies as it levels the playing field. Again this is
> a subjective evaluation however generally I would like to see a value of 4
> or higher.
>
> Total Trades
>
> The concept is simple; can the trader actually trade the system? How many
> trades a day (or whatever unit of time the trader wants to use) is the
> trader comfortable with? How easy is it to execute the trades? Is the
> execution method reliable? Generally I like 4-6 trades per day, however
> this is dependent upon the trader.
>
> Total Gross Profit
>
> Calculation: Total Profit less Total Loss
>
> This number is totally dependent upon the trader. Largely depends upon if
> the trader is trading full or part time. Must he trade to pay the bills?
If
> so, then the total net profit required will be dependent upon the traders'
> lifestyle. This doesn't include commissions or slippage.
>
> Average Winning Trade
>
> Calculation: Total Gross Profit divided by total winning trades.
>
> This number tells us the average amount of profits per winning trade.
>
> Average Loosing Trade
>
> Calculation: Total Gross Loss divided by total loosing trades.
>
> This number tells us the average amount of loss per loosing trade
>
> Average Win To Average Loss Ratio
>
> Calculation: (Total Profits divided total number of winning trades)
divided
> by (Total Loss divided by total number of losing trades).
>
> This ratio is based upon the average gain of winning trades, and the
> average loss on the loosing trades. While it seems similar to the NPT or
> Profit Factor it is not. This is because the other primary variable is the
> percentage of winning trades. With this ratio we can have a profitable
> winning system that will generate larger loosing trades than winning
> trades. The reason this is profitable is because the percentage of winning
> trades is more than 50%. Generally I want to see at least 2.5 or more -
> 250% more average gain than loss.
>
> Largest Loosing Trade/Average Win Ratio
>
> Calculation: Largest Loss divided by Average Profit per winning
trade.
>
> This ratio will indicate approximately how many winning trades it will
take
> to recover from the largest losing trade. Generally a value of 4 or less
> is good, I prefer 1.5 or better. As this is telling us that with 4 (or
1.5)
> average winning trades we will recover from the largest historical loss.
> Again this relates to the amount of pain a trader can endure.
>
> Largest Drawdown/Average Win Ratio
>
> Calculation: Determine amount money lost in the largest Drawdown divided
by
> the Average Profit per winning trade.
>
> This ratio will also give us an indication of the amount of pain that must
> be endured. We will know the approximate number of winning trades it will
> take to recover from the largest historical drawdown. When combined with
> percentage of winning trades we can then begin to estimate how many trades
> overall must be traded. Generally I do not want to see a ratio above 7.0.
> In other words this is telling me that in 7 winning trades I should
recover
> from my drawdown.
>
>
> Average Drawdown/Average Win Ratio
>
> Calculation: Determine the average amount money lost in the all of the
> Drawdown's divided by the Average Profit per winning trade.
>
> Similar to the previous ratio we will know the approximate number of
> winning trades it will take to recover our lost equity. When combined with
> percentage of winning trades we can then begin to estimate how many trades
> overall must be traded. Generally I want the value to be no higher than
1.0.
>
> Percent Profitable
>
> Calculation: Total number of trades divided by total number of
> winning trades.
>
> This ratio relates to the number you times you can make a losing trade
> without getting upset or doubting the integrity of trading logic. In my
> opinion it is the least important of the ratios in determining the overall
> profitability of a trading system. Generally I would like to see 50% or
> more - however it really doesn't matter all that much to me. The
percentage
> of winners is totally dependent upon the traders' psychological makeup.
>
> Maximum Number of Consecutive Winning and Loosing Trades
>
> Calculation: Determine the maximum number of consecutive winning and
> loosing trades.
>
> Average of Maximum Number of Consecutive Winning and Loosing Trades
>
> Calculation: Average the maximum number of consecutive winning trades.
> Average the maximum number of consecutive loosing trades.
>
> These two numbers will begin to tell us what we could expect in actual
> trading and will be one of the first indications that the trading logic
has
> gone astray when trading in real time. They are also totally dependent
upon
> the psychological makeup of the trader.
>
> A word of warning.
>
> The challenge of creating a trading system for an experienced trader is
> that he is attempting to create a mechanical version of himself. Computers
> are incredibly dumb machines and cannot change their "programming" on the
> fly. They are very systematic and they are not discretionary. This is
their
> weakness and their strength. Most experienced traders are to a certain
> degree discretionary in their day-to-day execution of trades.
>
> Because computers are very systematic they will always execute the code in
> the same manner with the same results provided the inputs are the same.
> Should the inputs change then the output will change. The goal of every
> trading program is to execute the same buy regardless of when the data
> stream was started. In other words if we are using 3-minute historical
data
> that starts on 4/1/01 and ends on 4/1/02, and our logic only needs 30 days
> of 3-minute data. If our system generates a buy on 10/1/01 1:30pm, and
then
> exits the trade at 10/1/01 2:15pm our goal is for the buy to be generated
> for 10/1/02 1:30pm regardless if the data stream being used starts on
> 4/1/01, or 8/1/01.
>
> All too often this is not case, the date and time the data stream begins
> will prevent the trade on 10/1/01 at 1:30 from being triggered. The goal
is
> that the trade consistently be triggered.
>
> Another problem is that using historical data to create a trading system
> will in actuality create a system that has been "curve fitted" to some
> extent - regardless if optimization studies were performed on the
> variables. This is because the system creator has the vision of 20-20
> hindsight. Curve fitting becomes apparent data from a different time
period
> is used.
>
> This is why the adage you read everywhere "past performance is not
> indicative of future performance" - because it is the truth. This is true
> of a computer based trading system or an individual trader!
>
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