TRACK YOUR TRADING RESULTS

You cannot coach your trading to success if you do not keep score. Keeping score is more than tracking your profits and losses for the day, week, or year. It means knowing how youre performing and how this compares with your normal performance.

Score keeping makes sense if you once again think of your trading as a business. A sophisticated retail clothing firm tracks sales closely every week. Retailers know not only how much theyve sold in total, but how much of each product. Perhaps the economy is slow, so womens accessorieswhich are lower-pricedare hot, but high-priced clothing is not. The company that tracks these trends regularly will be in the best position to shift their product mix and maximize profits. Similarly, if one store is dramatically underperforming its peers despite a favorable location, managers can use that information to see what might be going wrong at the store and make corrections.

Score keeping in the business world can be extremely detailed. There are good reasons for the investments in information systems that we observe among the worlds most successful corporations. Firms may track sales by hour of the day to help them determine when to open and close. Purchasing patterns based on gender and age are factored into advertising messages and promotional campaigns. Score keeping provides the business with knowledge; in the business world, knowledge utilized properly is power.

You cant properly manage your business if you dont understand what it is doing right and wrong.

Nowhere do we see this power more dramatically than in quality control. Firms such as Toyota collect reams of data on their manufacturing processes to help them identify lapses in quality, but also to make continuous improvements in manufacturing processes. If you dont collect the data, you cant establish the benchmarks that enable you to track progress. Its not just about ensuring that you do well; the best businesses are driven to do better.

When you keep score in your trading business, a few metrics are absolutely essential. These include:

Your equity curve, tracking changes in portfolio value over time. Your number of winning versus losing trades.

The average size of your winning trades and the average size of your losers.

Your average win/loss per trade. The variability of your daily returns.

Lets take a look at each metric in a bit of detail.

Equity Curve

Here youre interested in the slope of your returns and changes in the slope. As we saw with Henry Carstens tools that simulate trading returns, a great deal of directional change in your portfolio can be attributed to chance. For that reason, you dont want to overreact to every squiggle in your equity curve, abandoning hard-won experience. Too many traders jump from one promised Holy Grail to another, shifting whenever they draw down. A far more promising framework for your self-coaching is to know the equity curve variation that is typical of your past trading, so that you can compare yourself against your own norms. If you have learned trading properly, you will have a historical curve of your returns from simulation trading and small-size trading before you begin trading as an incomegenerating business. When your current equity curve varies meaningfully from your historical performance, thats when you know you may need to make adjustments. If the variation is in a positive, profitable direction, youll want to isolate what is working for you so that you can take full advantage. If the variation is creating outsized losses, you may need to cut your risk (reduce the size of your trades) and diagnose the problems.

Knowing your normal performance is invaluable in identifying those periods when returns are significantly subnormal.

Winning Versus Losing Trades

This is a basic metric of how well youre reading markets. Again, the emphasis is not on hitting a particular number, but on comparing your current performance to your historical norms. Lets say, for instance, youre a trend follower. You tend to make money on only 40 percent of your trades, but you ride those winners for relatively large gains compared to your losers. If your win percentage suddenly drops to 25 percent, youll want to diagnose possible problems. Has your market turned choppy and directionless? Have you altered the way in which youre entering trades or managing them? The more the drop to 25 percent is atypical of your historical trading, the more youll want to enter a diagnostic mode. If, however, youve had past periods of 25 percent winners just as a function of slow, directionless markets, you may choose to ride things out without making major changes in your trading simply by focusing on markets or times of day with greater opportunity.

Average Sizes of Winning and Losing Trades

It doesnt help to have 60 percent winning trades if the average size of your losers is twice that of your winners. Keeping score of the average sizes of winners and losers will tell you a great deal about your execution of trade ideaswhether youre entering at points that provide you with favorable returns relative to the heat that youre taking. The data will also tell you how well youre sticking to your risk management discipline, particularly stop-losses. If your average win size and loss size are expanding or con

tracting at the same time, you may simply be dealing with greater or lesser market volatility (or you may be sizing your positions larger or smaller). It is the relative shifts in size of average wins and losses that are most important for managing your business. If your winners are increasing in average size and your losers are decreasing, youre obviously trading quite well. It will be important to identify what youre doing right so that you can be consistent with it. Conversely, when losers are increasing in average size and winners are not, you want to figure out where the problem lies. Are you reading markets wrong, executing and managing trades poorly, or both?

Average Win/Loss Per Trade

Suppose you make a particular amount of money in January and the same amount in February. You might be tempted to conclude that you traded equally well in the two months. That would be a mistake, however. If you had placed 50 trades in the first month and 100 in the second month, then you can see that more trading did not produce more profit. Your average profit per trade actually declined. This suggests that at least some of your trading is not providing good returns, and that bears investigation. The situation is similar to that of a business that opens five new stores in a year, but reports the same sales volume year over year. The average sales per store have actually declined, an important factor masked by the increase in overall activity. Average win/loss per trade will vary with your position sizing and with overall market volatility. Be alert for occasions in which market volatility may increase, but your average win per trade goes down: you may not be trading as well in shifting market conditions. Many times, traders make as much or more money if they simply focus on their best ideas and reduce their total number of trades. This selectivity shows up as a soaring average win per trade. Its a great measure of the efficiency of your trading efforts.

When you trade more often, make sure that the incremental trades are adding economic value.

Variability of Daily Returns

If you take your wins and losses for each day and convert those to absolute values, youll then have a distribution of your returns. Youll see how much your equity curve moves per day on average. Youll also observe the variation around this average: the range of daily swings that is typical for your trading. The variation in your daily returns will ultimately shape the size of drawdowns you experience in your portfolio. Given that youre going to experience runs of losing days over your career, youll have larger drawdowns when those runs are 2 percent each than if theyre 1/2 percent.

Indeed, if you investigate the losing periods that are historically typical of your trading, you can use these to calibrate the daily variability you want to tolerate in your trading. This is central to risk management. If you want to keep total drawdowns in your portfolio to less than 10 percent, for example, you cannot risk average daily swings of 2 percent. Of course, if youre keeping drawdowns to less than 10 percent, you also cannot expect to be making 50 percent or more per year: risk and reward will be proportional. By calibrating the average swing in your portfolio per day, you target both overall risk and reward. If youre trading very well (i.e., very profitably) with a relatively low variation in your portfolio size from day to day, you can probably afford to gradually pick up your risk (increase trade size to generate larger returns). If youre trading poorly and losing money beyond your norms, you may want to reduce your daily variation and cut your risk.

What all of this means is that, when youre your own trading coach, you are also your own scorekeeper. The metrics above are, in my estimation, an essential part of the journals of any serious trader. The more you know about how youre doing, the more prepared youll be to expand on your strengths and address your vulnerabilities.

See David Adlers lesson in Chapter 9 for additional perspectives on trader metrics. A particular focus that is helpful is to examine what happens to your trades after your entry and what happens to them following your exit. Knowing the average heat that you take on winning trades helps you gauge your execution skill; knowing the average move in your favor following your exit enables you to track the value of your exit criteria. Sometimes the most important data dont show up on a P/L summary: how much money you left on the table by not patiently waiting for a good entry price or by exiting a move precipitously.