Your trading plan is a highly personal document, it’s not for the author of this article, or any other supposed experts, to tell you that it’s “right”, or “wrong”. Whilst some of us will contend that there’s only one way of trading, in order to consistently take money out of our markets, that’s an incorrect claim and assumption. What we actually mean by that statement is that we’ve discovered only one trading method that actually works on a consistent basis- a method that works for us.
Some methods will fail spectacularly, some will produce benign, inconclusive results, and some will deliver extreme levels of profit and loss. Others will produce steady, realistic profitable returns and it’s probably that latter description; the steady, realistic returns, that’ll most likely be the kind of strategy that you eventually settle on. Sadly, you’ll inevitably have to experience the pain of several, various losing strategies, in order to eventually arrive at this situation.
Establishing your trading plan
So how do you make a decision regarding the overall method in your trading plan’s efficiency and effectiveness, what metrics do you employ to measure your performance on an ongoing basis, to then decide that a particular trading strategy is no longer working? Do you measure it in terms of lost trades, the amount of money you actually lose, or do you apply a time period only, in order to judge its overall effectiveness? Alternatively, do you apply an element of these three core judgments to arrive at a decision?
The answer is that you’re probably best advised to consider each of these three metrics to make your ultimate judgment:
• How many trades have you lost?
• How much money have you lost?
• How much time have you lost, trading your latest method?
Firstly, as we’ve discussed many times, a coin toss should render an approx. 50-50% random distribution between winners and losers; if you take a series of trades based on chance only, employing no fundamental or technical analysis expertise, then you should come up with a 50-50% distribution between winners and losers. Therefore if you’re not achieving a 50-50 distribution then your method may be either out of synch with the market, or more likely it’s a method that’s never likely to return a profit. Although by no means cast in stone, perhaps if you’re achieving a loss versus wins ratio of 60-40%, then it’s time to reconsider your method and consign it to history.
Secondly, set yourself an absolute limit, in terms of the losses you’re prepared to suffer on the new strategy you’re employing. Perhaps it’ll be a maximum of 5% of your account size.
Let’s surmise that you’ll be risking 0.5% on each trade, therefore you’ll need to experience ten losses in series before you abandon it. Or if you’re experiencing a 60-40% loss to win ratio, then you’d perhaps need to experience six losses out of each ten trades before changing the trading plan. Perhaps you’d take twenty trades and lose twelve, before changing the plan.
Thirdly, in terms of time, let’s continue with the example we’ve just used in our 60-40% loss ratio and the example of losing twelve out of every twenty trades. Now we accept that the 60-40% loss rate is significantly above the 50-50% that random chance should deliver, therefore it’s an excellent ‘failure barometer’, now we add in time to that overall study. Let’s surmise that we’re a day trader taking two trades a day, perhaps we only trade the EUR/USD. Therefore our 60-40% loss would be measured over a two week period. Would and could we judge the performance of our trading strategy over a ten day trading period? Maybe, or if we think it should be longer then perhaps extend the period by lowering the risk.
Bear in mind that time is a precious resource, we can’t be wasting months on strategies that fail, we must be able to determine their effectiveness extremely quickly.