During the process of systematic trading, you rely on different indicators to analyze the performance of your trading systems. Most simulation engines produce performance reports at the end of each backtest. Some products focus on a few metrics, while others produce quite extensive reporting. Below you will find a list of the most popular indicators.
Basic performance metrics:
The first important performance indicator you should look at is the number of trades the strategy produces. There are two important reasons for that. The first reason is to estimate the statistical significance of the results. The second reason is to understand the frequency of trading.
The total gain is the second metric you should look at when evaluating the performance of a trading system. Most products will allow you to see this metric in money or pips. Our advice is to focus on the pips at this stage of system development. This is because the monetary result of the system will also depend on money management and we are going to focus on money management in a later stage of the trading system development process.
The winning percentage shows you what portion of your trades ends up with a positive result. It is a fairly popular trading performance metric, which however is frequently misunderstood. A fairly common misconception is that the higher winning percentage is better. Do a simple online search and you will find thousands of systems and mentors who offer you a trading strategy with a 90%+ winning rate. This marketing message applies very well to traders of the gambling and the “always want to be right” type. The professional traders know that there is much more to trading than that.
Having covered the winning percentage above, you now have a better understanding of how to use it when looking at trading performance reports. The next metric is called Expectancy. It will build on top of the winning percentage and help you evaluate systems better.
The Profit factor is another valuable metric you should consider when looking at trading system performance reports. It shows you the amount of profit you get per unit of risk you run. A value greater than 1 indicates that you have a profitable system.
One of the best performance indicators actually isn’t a metric, but a graph – the Equity curve. As the old saying goes “A picture is worth 1000 words”. You can easily understand the type of the system and if it is worth trading by a quick glance at the Equity curve. There are several types of equity curve you can observe:
Having cleared the most basic metrics, we are now moving forward to the ones that are mostly looked by professionals. The first such metric is the Maximum Drawdown. It shows you the “worst-case scenario” that occurred during a period of time. It measures the greatest loss from a previous peak of an Equity curve. This is an important metric because it shows how much is the maximum drop of Equity after a peak. Why is this important?
Advanced performance metrics:
Sharpe ratio is another performance metric used to evaluate the performance of trading systems. It is used to measure the risk-adjusted returns of a trading strategy. In the original concept developed by the Nobel laureate William Sharpe, the ratio is the average return earned in excess of the risk-free rate per unit of volatility or total risk. A simplified approach is used in FX and derivatives trading because the impact of the risk-free rate is mostly irrelevant. The simplified version is calculated as the average return for a particular time period divided by the standard deviation of returns for the same period.
Skewness of the returns distribution is not a very popular metric. As a matter of fact, you will not find it in most of the standard performance reports. Regardless of the fact that it is frequently underestimated it is a measure which can give you a better understanding of the trading system you are evaluating.