If you are backtesting your trading strategy you need some key figures to determine if your system is profitable or not. It doesn’t matter if you are testing a manual strategy or an automatic system. You need at least these eight key figures before you are going live and risk your money.
The profit factor is a value to check if your system is profitable over a longer period of time. The formula is
The value should be at least 1.4, values greater than 1.7 are recommended. It is needless to say that you shouldn’t even think about to trade a system with a profit factor below 1.1. Even if you have the best money management rules, you will loose your money over time!
There are two scenarios for a drawdown. The open equity and closed equity drawdown.
The Closed Equity Drawdown is the value from the high to the low of the maximum lost in your equity curve. The Open Equity Drawdown is the same as the Closed Equity Drawdown except that the open positions are included.
The drawdown value is important because you need as much cash in your account as the value of your drawdown. Sometimes the drawdown will happen at the very beginning of your trading. Your account size should be 1.5 times greater than your maximum open equity drawdown. Check the period how long the drawdown exists.
The hit rate describes how many winners compared to your losers you have. If you have a hit rate of 55% then you have 55 winners and 45 losers per 100 trades total. When the hit rate is lower than 50% it could be mentally very hard to trade such a system.
The average profit per trade is an important value. If you have a system with a high amount of trades but a low amount of average profit per trade, it could be very hard to trade the system. It could lead to more losers because of the variable broker fees and spread costs.
It describes the total amount of consecutive losers and could lead to the next drawdown value. Consider a higher value in live trading than in backtesting. At least 1.5 times higher. If you reach that value you should consider to take the system offline and check the conditions.
The value is the largest loosing trade in all your trades of that particular system. It is easier to have that value as a percentage instead of your account currency.
It represents the amount of money that you could lose on an investment. If you have 10,000 EUR invested in stocks, your exposure to stocks is 10,000 EUR or 100%. Yet, if your entire portfolio is worth 20,000 EUR and you are invested with 10,000 EUR in stocks, then your exposure to stocks is 50%.
The ARR is a helpful guide for measuring a funds or a systems long-term performance. However, if the yearly returns (those that produced the average annual return) were +40%, +30%, -10%, +5% and -15% (50 / 5 = 10%), performance over the past three years warrants examination of the fund’s management and investment strategy.Written on July 6th, 2019 by Arne Gockeln / Photo by Austin Distel on Unsplash