Sunday, August 16, 2009

08/16 Tracking the right stuff

This week I realized how important it is to keep track of you trading metrics. If you just keep on trading, you don't even know how good or bad your "money machine" is operating.

Trading, like any other business, needs a sound planning and monitoring approach in order to be successful. As a business owner, you need to focus on the right things in order to succeed!

Imagine you just opened a bakery. You make several types of bread, you don't really pay attention to which bread sells more, or which one the customers preffer, you just make them in many sizes and types to fill out your shelves so they look pretty.

Every day, you throw away old stale bread.. And you make some more in the next morning. Fill up your shelves, make them look pretty. Run a business like this, and I can make sure you'll run it to the ground really quick. As a baker, you need to know what your customers preffer, what sells more! And you make more of those types of bread, and less (or none) of the ones you end up throwing away in the end of the day. That should be the focus, not making the shelves look pretty, right?!?! You bake simple bread that sells and then buy some other stuff to make your shelves look nice.

How does it compares to trading?!?! In my case, I'm traking a few metrics every week, two of them are the most important ones in my mind: Risk to reward ratio and win-loss ratio. The combination of those two will tell me if I can make money on the longer run.

Well, here comes the trick! Which one do you, as a trader, think is more important?? Which one should you work on improving? The risk to reward or the win-ratio??

The win-ratio makes you look pretty! WOW, this guys wins 80% of his trades! He is a millionnaire!! NOT SO Quick buster!! If his risk to reward is horrible, say 20 to 1, he is certain to lose money in the long run. See my previous posting on risk to reward to understand why.

I made a small tweak on my trading to avoid taking a small loss when price approached the target and reverted back to break-even. This was an adjustment based on one week of trading where I had one or two trades that I closed at a small loss even after they were profitable. Well, this was not a good idea after all! The reason is simple: by cutting the trade short, I run the risk of cutting a few winning trades too soon, yes, I improve my win-ratio, but at the same time I cut my risk to reward way low!!

This week is an example, my risk to reward ratio came down from being 1:1 (or better) for 4 weeks in a row to a horrible 3:1!! I certainly do not want that type of set-up for my trading. I certainly don't care to look good (being the guy with a huge win-ratio), I much preffer to make money! Even if I make money by winning a small percentage of the time. Who cares?!?! So, I'm reverting back to my original trading plan, where I manage the stops and leave the take profit level alone.

I'll keep on tracking the scenarios where a trade fades from the limit and fails back to being stopped, but will only track those and eventually, when I have a lot more data to go by, will come up with another idea. For now, the simpler the better.


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