Analyze Trades
Every time a trade is completed, it must be analyzed to determine if it was executed according to plan, if the plan needs to be updated, and how effective the buy and sell signals are.
As more types of buy and sell signals are added to the plan and each are refined, it is important to keep track of the success rate for each type of trade in order to determine its effectiveness. Since trading is probabilistic in nature, a trading technique cannot be evaluated based on the success of one or a few trades, so there must be at least 10 and ideally 20 trades before such an analysis can be considered valid.
For each category of trades, keep track of the following stats over the lifetime of the technique, and on a sliding window of the last 20 trades:
- Number and percentage of winning trades.
- Average, minimum, and maximum gains per trade.
- Number and percentage of losing trades.
- Average, minimum, and maximum loss per trade.
- Total profitability of this technique.
If there is ever a trade that loses more than the maximum defined loss per trade, immediately determine the cause. If this was because of a failure to follow the plan, recognize the mistake and immediately work on correcting it for future trades. If it was something that could not be predicted, such as a gap down, analyze whether anything could have been done differently to mitigate the losses, such as being aware of upcoming news events.
Once a trade category has had enough trades, begin analyzing its success rate. While the percentage of winning trades is interesting, the most important criteria to consider is the profitability of the technique. If most trades are losers, but the dollar amounts of winners are much larger than the losers, the technique may still be valid. However, it is also important to consider how likely it is that long strings of losers will result in big losses, which is a function of both the percentage of winners/losers as well as the average/maximum loss per loser. Techniques that yield big returns but have a high likelihood of suffering long strings of losers should be avoided if possible.
Also, always look for other metrics that can be used to evaluate the validity and success rate of various trading techniques.
Analyze Total Portfolio
The most important metric to be tracked is the total value of the portfolio. The entire purpose of trading is to make money, and this can be measured by seeing a steadily rising equity curve across the portfolio. A rising equity curve is defined as a curve with a series of higher highs and higher lows.
Always monitor the total portfolio value, and analyze its behavior. If it does not exhibit a steadily rising curve, evaluate whether there is a flaw in the plan that is producing inconsistent results. If the equity curve is steadily rising, still look for ways to improve the plan, but be careful not to become too aggressive and remove safeguards that are intended to produce consistency.
