The reason we trade is to make money. The reason we want money is to have a better life.
The reason we want money is to occasionally get away from it all on a remote tropical island or send our bratty, undeserving children to the best damn schools we can. Or, just maybe, you decide the kids can fend for themselves and instead buy the mid-life crisis Porsche Boxster.
As you know, when we trade we take on risk and expose ourselves to the possibility of losing it all to Mr. Market. Unfortunately, many of us don’t truly understand the risk we’re taking on when we venture down the dark, scary path as we enter into a relationship with the
Here at QiT, we believe it is paramount you know your risk to reward ratio and maximizing this ratio should be where you place most of your energies whenever evaluating and making trading decisions.
1. When assessing an algorithm, QiT starts with the Compounded Annual Return (CAR). This number can be very seductive to investors and many don’t look any further. All QiT algorithms have CARs above 15%.
2. The next number, and the one I consider as important as the CAR, is the Maximum Drawdown, the maximum amount an account was down at any one point during the back test timeframe. This is one that plays havoc with our emotions and can reveal our true self – ok a little dramatic – but I do consider it so vital to understanding the system your trading I dissect it even further and calculate two more metrics.
- One is Maximum Drawdown Duration, the maximum time an account was in its Max Drawdown. The metric on the Performance Metric is called Max Days in Drawdown. Once again in order to keep it S&S, if you want more information, click the link.
- The next metric is an average of the top 5 drawdowns. I calculate this number for the simple fact that many times a Max drawdown does not reflect the health of a portfolio. Case in point, August of 2011. You can’t ignore that month (although I would dearly love to). Yet, you can’t use it as an absolute when assessing the viability of a strategy.
I struggled with this for years. I would look at the Max DD before the CAR and inadvertently, dropkicked some very good strategies not realizing that the Max drawdown was a spike down and the strategy recovered from it quickly. I recently penned a newsletter about an odd looking chart called the Underwater Equity Chart where you see this phenomenon as clear as the tomato sauce speckles on my white silk blouse after I eat spaghetti.
4. The next number we look at is the percentage of winners and losers and you’re probably asking, “If all the other numbers look good, what difference would it make that I have 90% losers and 10% winners, as long as I have the profit I need?” The answer to that is most traders would find it hard to continue trading if losers even equal winners (50/50 win loss ratio). We need more winners than losers for the psychological aspect. All QiT algorithms have the percentage of winners/loser ratio above 60/40.
5. Exposure % the sum of how much of your portfolio is exposed to market risk each day. The less exposure, the less chance you have of encountering the black swan events that will happen in your trading career. Notice I said “will happen” not “if happen.” All QiT algorithms have no more than 25-30% exposure.
6. Profit Factor This is taken from Investopedia since they did an excellent job of describing Profit Factor, “The profit factor is defined as the gross profit divided by the gross loss (including commissions) for the entire trading period. This performance metric relates the amount of profit per unit of risk, with values greater than one indicating a profitable system. “
We’re the Plan in “Plan your Trade and Trade your Plan” – TraderJanie
Sign up today