June 4: Discover Why It`s Critical To Run Your Trading As A Business – Secret Ways to Improve Your Trading Profits

by Dave on June 4, 2006

You can draw some useful parallels between running a business and trading. For instance, most successful businesses keep statistics on everything from their conversion rate, to their average dollar sale, to the number of people that come in the door. They do this to keep on top of how they are doing on a day-to-day basis. A successful business will do this because they understand you must first take score before you can begin to improve on that score. Trading works exactly the same way.

Now that you`re looking at trading as a business, you need to learn some valuable statistics about your system so you can improve its performance. You can`t improve your system unless you have something to measure it against. How could you expect to improve something unless you knew what it was you were looking to improve? You can discover these measurements, and other valuable information about your trading system, by back testing.

There are two ways that you can back test a system. You can do it manually, which can be drawn-out and labor-intensive process, or you can do it with the aid of some software packages. Unfortunately, I recommend you do it by hand when you first start out. You`ll get a much better feel for your system, and you`ll understand exactly how it works in all its intricacies. Once you have this in-depth knowledge you could look at finding a software package that does it for you.

There are a few major statistics on your system that you need that you will uncover through back testing. The first statistic you need to become familiar with is the R multiple principal. R stands for risk, the risk you take on any trade when you enter the market. The R multiple of a trade is the ratio of the profit or loss compared to the amount of money risked to make the profit or loss.

Therefore, if you risk $200 dollars in your initial purchase, and you make a profit of $1,000, you have made five times the amount you risked in the trade. You have an R multiple of five. This statistic gives you a good idea of the relative size of your profits to your losses. You can compare the average size of your winning trades and with the average size of your losing trades.

The next statistic you`ll find useful is your win to loss ratio. This is how many times you get a winning trade in proportion to how many times you get a losing trade. For example, if you had ten trades and four of those trades were winners and six were losers, your win to loss ratio is simply four to six. This is your hit rate, you get 40 percent of your trades correct.

With these two simple statistics, you can calculate the average size of your profits and of your losses, multiple these figures with your win to loss ratio, and calculate on average how much money you make with every dollar you risk.

For those of you who think this sounds like a too much work, particularly the back testing you need to do to uncover these statistics, consider this scenario. Imagine yourself trading a system that you knew had a win to loss ratio of 60/40. You made profit on every six trades and lost on every four. How do you think you would feel, and where would your confidence level be, if after you traded the system for a little while, you received a string of 11 losses in a row?

Now, you know that this system has a win to loss ratio of six to four. Would you have the confidence to open another trade if your system brought up another buy signal after getting 11 trades wrong?

Unless you`ve back tested your system, I doubt it. That trading system may have been a fantastically profitable system, however, since you didn`t back test it, you don`t know that historically, this system had received up to 13 losses in a row, and was still profitable.

Here`s another point you may not have picked up unless you have done the correct back testing. Once you`ve set your money management rules and you begin to trade, you will likely experience a string of losses. Countless times I`ve had clients who get disheartened by this fact because they don`t understand the nature of setting good management. If you`re adhering to the rules of cutting your losses short and letting your profits run, because you`re cutting your losses short, those trades are going to last for a shorter amount of time.

This means once you begin trading the odds of getting losses early in the game are much higher than getting a winning trade. This is particularly true when you consider that many successful trading systems run on a 40/60 win to loss ratio. However, you will never know the intricacies of your system unless you back test it.

Back testing will help you to understand what works and what doesn`t. It will give you the statistics to gauge the effectiveness of your trades. It fills in your score card, and allows you to make improvements. But you shouldn`t simply believe everything I`ve told you. Instead, you need to prove it to yourself by back testing your system.

——————————————
This article has been extracted from David Jenyns` Trading Secrets Revealed Course. Unfortunately this course is currently sold out. To be notified if and when extra copies are released, please send us an email and we`ll let you know when you can purchase a copy of this highly recommended course. Click Here and send us an email. and be sure to mention you want to be on the `Trading Secrets Revealed Waiting List`.

Share

Previous post:

Next post: