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Tate on Trading – Eye on Performance

Lately, I’ve had a few e-mails regarding which type of performance stats traders should be keeping. Since trading is essentially a small business, it is necessary for us to track our performance to see how we are doing. Simply looking at raw returns presents us with a picture that is incomplete. So in this blog I want to look at some of the more common measures that traders should be aware of.

Before I begin, here is a little pop quiz for you to complete and then annoy your friends with when they come around to dinner and rabbit on about trading.

Assume that in Year One of your trading career you make a 100% gain and in Year Two make a 50% loss.

  1. What is your average return for the two years?
  2. How much money have you made?

The answer to these questions can be found at the end of this article.

There are several basic measures that every trader should have access to. These include:

  1. Total number of trades
  2. Number of winning trades
  3. Number of losing trades
  4. Points b. and c. as a percentage
  5. Average winning trade profit
  6. Average losing trade loss
  7. Largest win
  8. Largest loss

I consider these to be very basic measures that allow us to make more defined judgements about the progress of our business.

They enable us to make what I consider micro judgements such as our expectancy. Expectancy is a measure of system efficiency. It’s an extremely important statistic for every trader to be aware of.

However, the true macro progress of our business is tracked via two key points.

  1. Equity Curve and
  2. Drawdown

Equity Curve

Our equity curve is the heart of our business record. It tells us at a glance whether we are making or losing money. However, as we saw in last month’s article, simply taking our beginning and end equity values presents us with the problem of how do we track equity additions and withdrawals. Accounting for these is generally quite hard.

An additional problem that we face is do we track our open equity, which is essentially our market-to-market value at a given point, or do we wait till a trade is closed and begin to build a closed equity curve.

The tracking of open equity is quite easy – you simply look at the balance of your account at the end of the day/week/month and incorporate that figure. Unfortunately though, we are back to the problem of what to do with additions and withdrawals from the account. This is a problem that can only be solved manually by either looking at time weighted returns or converting your capital into a units fund in the same way that investment funds do.

Open equity curves also display extreme volatility, as the market value of each position swings around. This can be extremely problematic in leveraged accounts such as those used by CFD traders.

The degree of gearing and its subsequent volatility may not give an adequate presentation of the efficiency of your system. The large swings may also give you a severe gut-ache; since people who view open equity have a hard time accepting that the money they see is not theirs until the position is closed.

A closed equity curve takes on the following appearance.

(note: this equity curve was created using Stator trading software)

This is a simple record of the profitability of your trading system as trades are closed down. If find this method of equity tracking to be much easier on the nerves.

Drawdown

You will notice in the above chart that there are a series of peaks and troughs. I tend to pay more attention to the troughs since these are periods during which the system is in drawdown. In plain terms I am losing money.

Within the measurement of drawdown you will need to look at:

  1. MaxDD
  2. The number of days spent in drawdown
  3. The number of days at your equity peak
  4. The number of days that the system is flat

Traders are often frightened of drawdown because of the implications of losing money. Drawdown is a natural function of all trading systems – systems don’t continually make endless series of new equity highs without pause and retracement. If anyone tells you that their system has never had a drawdown then they have simply forgotten to take their medication for the day.

As an example consider the following breakdown of results.

This performance data belongs to Eckhardt Trading Company, a trading fund run by William Eckhardt, one of the founders of the Turtles Trading Group. As you may be aware, The Turtles are one of the most successful trading groups ever, so it’s interesting to watch their performance.

A few things are noticeable about the distribution of returns.

  1. There are 81 losing months. So for 40% of the time the return for any given month the return will be negative.
  2. This equates to 2 days of the week being really bad days at work.
  3. January kicks off with some large drawdowns.
  4. The largest drawdown is 29.08%, this is the equivalent of starting a trading period with $100,000 and by the end of that period having $71,000 left and then having to recover. This fund has had a drawdown of greater than 20% seven times to date.

To get a true sense of the performance of this fund it is also necessary to add back in the performance fee of 20% that Eckhardt takes. For example, in 1995 the stated return is 46.02% – the true performance is actually 55.22%

To give you a sense of the reporting requirements of those who manage money the full report of Eckhardts various trading groups can be found at  http://www.iasg.com/mainframe.asp

With these two macro measures – equity curves and drawdown – you are more than able to track how your trading business is functioning. However, as the answers to the small quiz I posed earlier show, your returns are not as obvious as you may expect.

Answers to quiz:

  1. Average return 25%
  2. Amount made $0

So, to excel in the trading game, you need to keep accurate figures regarding your performance. It’s important to be honest with yourself how you are really progressing so that you can make improvements where necessary.

– Chris Tate

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The Trading Game Pty Ltd (ACN: 099 576 253) is an AFSL holder (Licence no: 468163). This information is correct at the time of publishing and may not be reproduced without formal permission. It is of a general nature and does not take into account your objectives, financial situation or needs. Before acting on any of the information you should consider its appropriateness, having regard to your own objectives, financial situation and needs.

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