Trading Tips

Gauging trading performance

There’s a recent post from the SMB blog that brings up an issue a lot of traders have – or at least think they have. Namely, they want to know how they are doing with their trading in terms of when they’ve reached a degrees of success. Here’s the main part of the query that came in from the trader asking the question:

I have been profitable every month since and including August of this year. Month to date December I am profitable as well. Before that I saw trickles of black but was always losing on balance and never had two consecutive profitable months until recently. I would greatly appreciate if you could shed some perspective on how I am doing based on my results. I am taking the money up every month so the only way to assess my results is based on percentage gains for a given month based on the account size traded that month. 2011 is my 4th year as a developing trader. For August through December (MTD) I sat down to trade 76 days and took 118 trades averaging 1.55 trades per day. My win ratio is 55.78% excluding scratches. My winners are 43% larger than my losers on average. I am in my winners 2.68:1 longer than my losers. My average risk per trade is 1.02% of the account size for a given month. The max risk I took on a trade was 1.65% of the account size. Nothing crazy risk wise. I always have a hard stop in the machine -always…and I never ever cancel it. For the 4 months August through November (2011), I have an average gain of 2.32% of the account total for that month. (6.7% the best/August -3.3% worst/September)

There are a few things that can be extracted from this:

  1. This trader has been going at it for several years and only now is finding his feet as a profitable trader. This is very common because the majority of folks who start trading really have no idea where they are going or what they need to do to get there. Figuring that out (usually through trial and error) often takes literally years.
  2. The trader had spells of profits, but was generally losing until the last few months. This is the standard pattern because consistency is lacking and developing traders often don’t know why they are struggling. And even when they figure it out, they still have to consistently implement the required change to get things sorted out.
  3. The trader understands the value of keeping track of his performance statistics, which too few traders do. The step he’s lacking here is the objective benchmark against which to measure his performance – at least so far as he’s communicated.

What this person is looking for from evaluators is whether he’s making enough from the markets – and also whether his performance has reached a level of predictability to suggest that it’s OK to add money to his account (that’s a separate part of the email). The numbers certainly look good. The problem is, though. we don’t have any way to tell him whether his results are good in the context of his trading method/system and repeatable or not.

Just as a start, we don’t know whether he’s trading a consistent system or multiple different ones. We also don’t know whether he’s being consistent in the application of his system or methodology. An additional question is why he’s only traded 70 days during the period in question. What’s the cause for not trading on the other days and does that have an implications for his performance?

I can also think of these other questions:

  • Do you ever have multiple positions on at a time?
  • If you’re risking about 1% per trade, why are only only making about 2.3%/mo given the number of trades done per month?
  • How much time is being put into the trading?
  • Given the numbers provided, the trade expectancy is about 0.355%. How does that compare to prior performance of the system/method employed, or to how the system should have been employed over the time period in question?
  • Can the system/method be used in a more frequent fashion to produce higher returns?

There’s a lot that has to go into actually judge trading performance. Just looking at the return figures isn’t going to be enough in a case like this. The best approach for any trader in this kind of condition is to try to figure out how they could/should have traded their system or methodology over the period in question and compare that to how they actually did. If the two are a close match, then you’re at least doing that part of it right. It then becomes a question of whether the system’s performance can be sustained and scaled up.

Trading Tips

Traders can do what athletes can’t

There’s a post on one of the BabyPips blogs which discusses the comparisons between elite athletes and successful traders. I will definitely not deny that there’s a lot in athletics which carries over well into trading. The aforementioned post mentions some of them:

  • Competitiveness
  • Solid “fundamentals”
  • Emotional toughness
  • Focus on continuous improvement

Here’s where the author comes up a bit short in his analysis, though.

In sports the thing which tends to differentiate elite athletes from the rest is physical. The author uses basketball in his examples. Let’s face it, though. You can be the fiercest competitor, have rock solid fundamentals, be emotionally tough, and constantly work to improve your skills, but if you’re short with no jump and slow afoot you’re not going to make the NBA. Flipping that around, if you’re 7’+ you can get away with short-comings in many other areas and still have a good career.

I bring this up because the features noted above can be found in athletes at all levels. I certainly saw them in college volleyball players I coached, though none of them had the physical tools to be All Americans or National Teamers. That doesn’t mean they did not have enjoyable, satisfying careers, though. They just had to focus on getting the most out of what they had in the context of their limitations. In sports the mental stuff can separate an individual from others with comparable physical tools, just as superior physical abilities can separate an individual from peers with similar mental abilities.

This can apply to trading as well. We just need to replace the physical element with the financial one. After all, if you have a lot of money you’re able to make a lot of money from the markets, even if your rate of return isn’t very good. Flipping that around, if you’ve only got $1000 you’re not going to be able to make enough money to live on – at least not consistently or without being constantly on the edge of complete ruin.

Of course the difference in trading is that you can save up and use compounding to increase your account and maybe eventually become that 7-footer, though it takes a lot of time and effort is you’re only starting off as a 1-footer. 🙂

Trading Tips

The new trader system loop

A poster at Trade2win started a discussion recently which I think is very worth addressing here. It starts off with looking at the typical process of the unsuccessful trader:

1. Find or develop a system you think will work
2. Trade the system
3. Experience a few losers and discard the system

Sound familiar? Probably so. It’s a very common loop new traders get caught up in.

Why is this so? Why do new traders give up so easily, when successful traders follow through?

The suggestion is that this happens because of a lack of confidence. While I can understand the case to be made for that being a problem, I’d take it a step further and say that it starts much higher up than that with the fact that new traders totally fail in the vast majority of cases to think beyond the immediate and develop a proper frame for their trading.

To put it simply, if you don’t know what you’re working toward how can you have any confidence that what you’re doing will get you there?

That’s high level thinking, of course. At a more ground level view, I’d contend that most new traders never learn what the elements of a trading system really are and how they contribute to its performance in different market conditions. They just want to plug-and-play and have profits come spilling out. The markets tend to disavow them of that impression quite rapidly.

Reader Questions Answered

Picking the right indicator(s)

This question came in the other day from a developing trader on the subject of technical indicators.

Dear Mr. Forman,

I’m a subscriber to your trading e-newsletter. I have a market question that I’d like to ask you. I often see it written on different market websites where they say that traders should use some kind of Technical Indicators on their charts to help determine the strength on a trend. I’m strickly a retail day trader (amateur lol), and mostly on using a 50 day moving avg on my charts and drawing my SR lines. I’ve tried lagging indicators like the RSI and MACD but they only seem to confuse me. I’m wondering which Indicators you think would be the most helpful to use for the shorter time frames that day traders trade in. Thank you so much and I look forward to your answer.


The first thing I’d point out is that all indicators are lagging in some fashion. Germain mentions RSI and MACD, but anything that uses historical data – and that’s all of them – has a built in lag effect to it. The further the look-back period, the greater the lag.

Now, certain indicators are meant to filter out the noise. Moving averages are in that category. They are meant to smooth out the ups and downs to indicate overall market direction. Longer moving averages will smooth out more volatility, but will be less responsive to market change, while the opposite will be the case with shorter averages.

RSI and other oscillator type of indicators basically tell you where the market is in reference to where it’s been. The idea there is that if it moves too far in one direction it will be overbought or oversold. The problem is that doesn’t work so well in a trending market.

To my mind, the best indicator of trend is the chart. Which way is it sloping? Stepping up a time interval from the one you’re trading to a higher one to look at the bigger trend can be very helpful. Again, you’re looking at history, so you there’s always a lag effect in your analysis (a trend will change before that change can be seen on the charts), but that’s just what we have to deal with.

No matter what I say, though, indicators (or the lack thereof) are an individual choice. We all have to pick things to look at that give us the specific information we require – and preferably no more than that. Decide how you want to trade and pick the things which help you identify trading opportunities or analyze the markets based on that approach.

Trading Book Reviews

Book Review: Currency Trading for Dummies

[easyazon-link asin=”1118018516″][/easyazon-link]I was given the opportunity a little while back to pick up a copy of [easyazon-link asin=”1118018516″]Currency Trading for Dummies[/easyazon-link], written by Brian Dolan. I’m always on the look out for good books to help introduce trading, either generally or in terms of specific concepts. I thought this book might make for a good resource I could recommend when asked about “a good forex trading book”. With that in mind, here’s my review.

Overall, I’m mixed on [easyazon-link asin=”1118018516″]Currency Trading for Dummies[/easyazon-link]. The book could have been structured much better to my mind and there are parts where I don’t care for the way the author has talked about things. There are, though, also some pretty good, useful parts.

The discussion of forex trading mechanics could perhaps have been done better. I think the author too closely associates it with the likes of stock trading in terms of buying and selling. It makes the general point, but could leave some readers with the wrong impression of how things work in retail forex in that it may imply to readers there’s actual currency ownership involved, which isn’t the case.

I also found the section on order types rather clunky. It takes up much more space than is necessary to talks about stop and limit orders, even accounting for the different ways they are referred to in some cases.

The author takes a very thorough look at interest rates, monetary policy, and currency policy in his discussion of drivers of exchange rates. Dolan goes into sources and types of information and the major economic and other data elements that go into forex market analysis. This includes a listing of the key reports for each of the major economies, though I would suggest that these things tend to change in importance over time.

The section of the book I think a lot of readers will find most valuable is the one which goes through the major currency pairs and talks about their individual characteristics. This isn’t something I’ve seen done in such detail in other books. This includes both technical and fundamental considerations for those pairs.

There’s also a good section on risk. It does a nice job of explaining leverage, margin and position-sizing, as well as addressing other elements of position and general trading risk.

The latter part of the book gets into subjects having to do with trading strategy and touches on subjects which aren’t strictly forex related, but will be of value to many readers.

My inclination is to compare this book to Essentials of Forex Trading. I think the latter book is a tighter look at the basics of foreign exchange trading. [easyazon-link asin=”1118018516″]Currency Trading for Dummies[/easyazon-link] is a more expansive text, going beyond the basics to take a more comprehensive view. Each has its strengths and weaknesses. I think maybe the two together provide a good comprehensive job of explaining forex trading to someone new to the market.

Make sure to check out all my trading book reviews.

Trading Tips

One trading forum post, numerous trader mistakes

The following is a post I came across on a trading forum not too long ago (can’t recall which one at this point). It speaks to a couple of important topics new traders face all too often.

Just started a account of 2,000 us dollars . Before I did I played on the practice account and made a 50k account to 100k in 13 days. I was confident in winning if I started a real(live) account. My first day I made a 220 dollars roughly and 130 pips . Second day I lost 80 dollars . And today which is my third day isn’t going well . I need advice in what to look at and how to come to a good conclusion . What I look at is low and high of the day and news feeds then I buy according to info I gather .

How many mistakes can we come up with from this trader’s story?

Here’s a good start:

  1. He believed 13 days of demo results was a significant sample size upon which to base a judgement.
  2. His risk on his demo trading was much too high as indicated by the 100% gain in such a short period – unless he was just extraordinarily lucky, in which case, see #1.
  3. He may have put too much money into live trading, though I can’t say that for sure. It depends on what $2000 represents in his financial position. I’m all for getting to live trading quickly, but I’m also for doing so with as little money as you can get away with.
  4. The risk he took in live trading is likely too large as shown by an 11% gain his first day.
  5. He went into live trading without a confident plan, as indicated by his request for help with his strategy after only a couple of days of losses.

I’m sure you can come up with others, and if so, post them below in a comment.

This forum post, to my mind, is just another example of a trader who got way ahead of himself. He never took the time to really develop a plan for his trading, leaving him in that all-too-common situation of feeling the need to jump to a new idea or strategy when the current one seems to be faltering.

Trading Tips

Drawbacks to packaged trading systems

There’s a post on the Winners Edge Trading blog that looks at automated trading systems. The article takes a very negative view on these systems, focusing mainly on ones that are being marketed and sold. The case against them are as follows:

  1. Many system sellers don’t actually care whether they work for you or not.
  2. The system creator(s) don’t do sufficient testing to come up with significant, trustworthy results.
  3. The system is built around recent market conditions, which stops working as soon as conditions change.

Of course the post then goes on to talk about all the things they do with their own system(s) – which they then promote – in order to overcome these three issues. Unfortunately, even the most sincere, honest, and ethical system developer cannot account for the fact that most systems won’t work for most people because they are not a good psychological fit for the user.

I am personally not in favor of buying trading systems. You are much better off researching and developing your own. It’s much more likely to be a good fit for you and to be something you can stick with.