So what does it take to get over the hump? What required to cross into profitability? How can I gauge my performance on a day to day, trade to trade basis?
The truth is in the cold hard numbers. Regardless of your methods for entering trades (hopefully you are consistent in your approach). We have to look at what we are producing, and if you want more meaningful information, this look goes deeper than a simple P/L statement or equity curve.
Many traders have some ambiguous view of what it takes to be profitable. They typically have nothing attaching them to the truth; nothing grounding them in facts. Know the truth, and the truth will set you free right? Most new traders I talk to are searching for some optimal "setup". Searching for some perfect way to enter into trades. That will never be found.
Looking deeper brings us to the analysis two key stats for traders: win% and our win:loss ratio.
"win %" is the percentage of total trades that are winning trades.
"win:loss" ratio is the size of your average winner divided by the size of your average loser.
If we take a look at these measures together, we find there is an optimal combination of the two that takes the trader across the threshold of losing into winning territory. Let's see it graphically.
This is an x-y plot of the two measures we're looking into. The red line represents the threshold of profitability. If your combination of win% and win:loss plots you directly on the line, you are breaking even for your trades. If you are anywhere to the left/below of the red line, you are, unfortunately, losing money by trading. If you cross over to the right/above, you're making money.
Now, once we understand and create the basic graph in excel. We'll want to add our trading data. You can use a variety of ways to calculate your win% and win:loss ratio; I personally use a rolling 20 or 30 trade average of both win% and win:loss. This shows me some things we'll talk about shortly. You can adjust this to whatever you like, and what information you're wanting to gather. You could use a rolling 20-session period, or even an annual figure. The point is you can make it fit your style and method.
Here's two examples of how we can drill down beyond the basic info of profitable/not profitable:
Example one:
Our rolling average starts at the green dot, and ends where we are presently at the orange dot.
This trader is drifting to the left on the plot. What does that mean? This trader held their win:loss ratio constant, but their win% is declining. This screams, "Selectivity!" to me. When I see this drift, I am not being patient enough and waiting for optimal, high probability setups. Time to be more selective and drift back to the right.
Example two:
Again, we started at the green dot, and ended up at the orange. This trader drifted straight down. What does this mean? The trader is doing a good job with trade selectivity because the win % is holding constant. The problem is in the old saying, "Cut your losers short and let your winners run". This trader is taking profits too quickly and/or allowing losing trades to go too far.
Based on your own trading style and method, you'll start to find where your "sweet spot" is on this graph. When you see a directional drift away from it, you'll know where to focus on improving your trading plan.
If you're not yet profitable, you can apply these same analysis tools to work your way across that line!
Happy trading everyone.
-IT7
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