Now that 2012 has come and gone, it's time to review how things went for the year. I feel that it is important to record all trades taken so that one's performance can be objectively assessed on a monthly or yearly basis.
I calculate earning 14% for the year, including dividends (which is slightly worse than just simply buying and holding the S&P 500.) There are other metrics you can use to assess your own trading besides this, however.
One such metric to assess performance is win rate. I placed 31 trades for the year, of which 17 were winners, giving me a win rate of about 55%.
Another (and in my opinion more important) metric is win/loss ratio. This is where you take your average winner and divide it by your average loser. For me, this number was 1.28 for the year.
With these two metrics, you can plug in your performance into what trend follower trader
Nick Radge calls a break-even curve:
In the above chart, I have drawn a red oval indicating where my 2012 trading performance stands. In addition, what this charts demonstrates, is that, for example:
- You can be 80% accurate and be a consistently losing trader
- You can be 20% accurate and be a consistently winning trader
In other words, as Nick Radge himself says, "the amount you win when you win versus the amount you lose when you lose is more important than trying to be right."
As a practical example, I could easily create a trading system that would be at least 95% accurate. All you'd have to do is buy stocks and place a limit order 10 cents above your entry price. In almost every case, your limit order would get picked off and you would be generating small profits left and right. The odd time, however, your limit won't get hit, as the stock tanks, leading to an enormous loss.
Option sellers are another example. You could sell deep, out of the money options and collect a premium every month. Strategies such as these generally earn 1% per month, with a very high win rate - until something unexpected (like the credit crises) comes along and wipes out years of profits.
Conversely, the Forex trading system that I am experimenting with is only expected to be profitable 25% of the time. The reason for this is that my stops are very tight, so I generate small losses often. On occasion, however, the price gets away on me, resulting in a win that can cover the cost of many small losses.
Here is a quote from The New Market Wizards interview of William Eckhardt that to me seemed profound at the time, but am only now fully starting to understand:
The desire to maximize the number of winning trades (or minimize the number of losing trades) works against the trader. The success rate of trades is the least important performance statistic and may even be inversely related to performance.
