Many of today’s market analysis platforms enable traders to evaluate both actual and theoretical trading activity by generating a strategy performance report — an objective evaluation of a trading strategy’s performance. A strategy is a set of precise rules used to enter and exit the market, and strategy development involves defining those rules by using historical backtesting, optimization and forward testing to determine the most effective and potentially profitable parameters for the system. The report estimates how well a strategy should work.
A strategy performance report is a vital component of the process that helps traders identify the strengths and weaknesses of a system, and quantify the system’s viability using a series of mathematically based performance metrics.
Quite often, even experienced traders fall into an analysis rut, relying on the same numbers and interpretations to evaluate their trading systems. For all of us, beginning and experienced traders alike, it’s helpful to step back and reconsider what our system reports are telling us.
There are dozens of performance metrics that can be used to evaluate a strategy, and traders often develop a preference for the metrics each finds most useful to his or her own trading style and goals. “Performance snapshot” (below) shows an example of the summary page of a strategy performance report, which includes an overview of all trading activity for the specified period.
Using a performance report effectively is not always straightforward. While it is exciting to zoom in on metrics such as total net profit or percent profitable, each metric alone does not provide a comprehensive view of the strategy. Consider, for example, a strategy that boasts a 90% profitable statistic, meaning that 90% of the completed trades during the specified period made money. While this appears to be good news at first, it does not provide a clear picture of the strategy’s performance.
A deeper analysis would consider factors such as the size of each winning and losing trade. In an extreme case, if 90% of the trades had an average winning trade of $5, and the remaining 10% of trades had an average losing trade of $500, it would be a losing system.
As another example, a strategy performance report could indicate that a system has a total net profit of $800,000. That might be an encouraging figure, but traders also must consider the maximum drawdown or the account size required values to determine how much money is needed to make that $800,000. It could be that the trader would need a much larger account, or would need to sustain greater losses than is comfortable, to trade the strategy.
The metrics have to be considered separately as well as collectively to produce an accurate assessment of the system’s performance.