Daily sit down with IT7 - MAE and MFE - Actual risk reward vs hypothetical/planned

First a primer on MAE and MFE for the newbies.  If you already know, pick up later on in the article after the pretty picture.

MAE stands for "Maximum Adverse Excursion" and it represents the maximum distance a trade goes against you over your holding time.

 MFE is the "Maximum Favorable Excursion" and it shows the maximum distance a trade ever went in your favor during the trade.

 A trade example: You buy crude oil at 97.00; it trades down to 96.80, then runs up to 97.40 , then falls down to 97.20 and you exit your trade there.

 Here's the anatomy of that trade visually, the way most of us traders like to see it:







Your MAE would be -20, the 20 ticks the market traded against you at the worst point. At the red circle.



Your MFE would be +40, the 40 ticks that the market went the most in your favor.  At the blue circle.





Ok, we get the concept, thanks for over-simplifying that IT7.  How do we apply it?  How do we become better, more knowledgeable traders from it?

There are several ways, but unfortunately some manual labor is usually involved for my favorite.  Don't all traders love excel??

My favorite way of using MAE and MFE together is something I recently heard talked about in a webinar, it is a great overall trading webinar btw and should be checked out futurestrader71 on risk and probabilities  Here's my takeaway and how I am applying it:

Create an excel chart to show MAE, MFE and P/L for each trade you want to include.  See how to create the spreadsheet here.

Now, what we want to look for is... you guessed it... risk to reward in our trades!  It's one thing to have hypothetical risk:reward when we enter a trade, but it is another to actually, consistently apply it and have it show up in this analysis.

This is really the key here.  We're simply adding a tool to monitor that we are keeping in line with ACTUAL risk and reward parameters that you set out to accomplish with your individual trading methodology and plan.

Here is mine plotted from today's CL (crude oil) trades I took on the live webcast:

I started out the day with my first five trades consisting of four losing trades, and one breakeven.  A few things I gather from this MAE/MFE graph:

a) I was getting just as much upside movement as I was getting downside movement on those first five struggling trades.  This is good to know that my timing wasn't totally wrong, and I'm seeing nearly a 10 tick push in my favor when entering trades.  I have a good bead on short term orderflow.

b) I can start to pay myself on a small portion of my position when I get those 10 ticks to help offset risk.

c) I am managing downside risk well, in accordance with my trade plan and method.

d) My last three trades were simply timed beautifully.  I hardly had any price movement against my position.  I was in nice sync with the flow and rhythm of the market.

I hope this article has been helpful.


Other, more traditional, ways to use MAE/MFE:

The most common way I see these used are with a MAE and P/L graph.  You can see where your trades tend to hit a "point of no return" and the odds of them coming back to profitable are getting quite slim.  This is a good area to consider having your stops placed.  If I know most trades that ever went more than 12 ticks against me are rarely profitable, I should probably be exiting trades that get to the -12 tick point in a hurry.  No hoping for a turnaround!

You can use the common graphs which plot MFE with your P/L to give you a good idea where you can safely add to positions.  You may see a point where collectively, if your trades get to X amount of profits, they tend to have a good chance of continuing to X+Y.  I don't personally use this, but it can be useful.