AriaS
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To assess how good a strategy is we need to see its stats.
The first thing most beginners care about is return or profit factor (PF).
In this post we will see why these metrics are meaningless and which one is your most reliable one.
Return says nothing about the risk taken. A strategy that made 10% with 5% drawdown (dd) is much better than one that made 20% with 20% drawdown. The first strategy can simply increase its trading volume x4 and make 40% with 20% dd. It made twice as much than the 1st strategy with the same risk.
Profit Factor (PF) doesn’t account for drawdowns. It simply shows the ratio between closed winning trades and closed losing trades. So once again, same as return, it doesn’t “know” or “care” about your risk. A strategy with PF=1.2 can be more profitable and stable than one with PF=7.0 .
Recovery Factor (RF) is one of those metrics that can really tell you how good your strategy is. RF = net return / max dd. It has its standards for different trading periods, because our return accumulates over time. A strategy that trades only 1 month cannot be judged as one that trades for a year. Your max dd could happen in the 1st month but you still didn’t have enough time for a nice return.
The next table of standards is only an approximation.
But it’s clear to anyone that making less than 15% per year with 10% dd would seem not worth it to most traders, while making 40% per year with 10% dd looks better than long term investing in stocks.
1 month of trading (not reliable)
< 0.5 poor
0.5 - 1.0 acceptable
1.0 - 2.0 good
3 months
< 1.0 poor
1.0 - 2.0 acceptable
2.0 - 3.0 good
6 months
<1.2 poor
1.2 - 2.2 acceptable
2.2 - 3.5 good
1 year
<1.5 poor
1.5 - 2.5 acceptable
2.5 - 4.0 good
Examples
After 3 months +8% with 10% dd - poor
After 1 year +30% with 10% - good
Next time about Sharpe Ratio that completes Recovery Factor.
P.S. I know that this table might look ridiculous to some beginners that expect to be making 300% per year with 10% dd
The first thing most beginners care about is return or profit factor (PF).
In this post we will see why these metrics are meaningless and which one is your most reliable one.
Return says nothing about the risk taken. A strategy that made 10% with 5% drawdown (dd) is much better than one that made 20% with 20% drawdown. The first strategy can simply increase its trading volume x4 and make 40% with 20% dd. It made twice as much than the 1st strategy with the same risk.
Profit Factor (PF) doesn’t account for drawdowns. It simply shows the ratio between closed winning trades and closed losing trades. So once again, same as return, it doesn’t “know” or “care” about your risk. A strategy with PF=1.2 can be more profitable and stable than one with PF=7.0 .
Recovery Factor (RF) is one of those metrics that can really tell you how good your strategy is. RF = net return / max dd. It has its standards for different trading periods, because our return accumulates over time. A strategy that trades only 1 month cannot be judged as one that trades for a year. Your max dd could happen in the 1st month but you still didn’t have enough time for a nice return.
The next table of standards is only an approximation.
But it’s clear to anyone that making less than 15% per year with 10% dd would seem not worth it to most traders, while making 40% per year with 10% dd looks better than long term investing in stocks.
1 month of trading (not reliable)
< 0.5 poor
0.5 - 1.0 acceptable
1.0 - 2.0 good
3 months
< 1.0 poor
1.0 - 2.0 acceptable
2.0 - 3.0 good
6 months
<1.2 poor
1.2 - 2.2 acceptable
2.2 - 3.5 good
1 year
<1.5 poor
1.5 - 2.5 acceptable
2.5 - 4.0 good
Examples
After 3 months +8% with 10% dd - poor
After 1 year +30% with 10% - good
Next time about Sharpe Ratio that completes Recovery Factor.
P.S. I know that this table might look ridiculous to some beginners that expect to be making 300% per year with 10% dd
