You can draw some useful parallels between running a business and
Day Trading, Forex or Currencies trading. For instance, most successful
businesses keep statistics on everything from their conversion rate, to
their average dollar sale, to the number of people that come in the
door. Businesses do this to keep on top of how they are doing on a day
to day basis and businesses must first take score before begining to
improve on that score. Using a Day Trading, Forex or Currencies back
testing plan in your trading works exactly the same way.
Now that you`re looking at Day Trading, Forex or Currencies
trading as a business, you need to learn some valuable statistics about
your system so you can improve it`s performance. You would use a Day
Trading, Forex or Currencies back testing method. You can`t improve
your system unless you have something to measure it against. How could
you expect to improve your trading unless you knew what it was you were
looking to improve? You can discover these measurements and other
valuable information about your trading system, by using a Day Trading,
Forex or Currencies back testing plan.
There are two ways that you can use a Day Trading, Forex or
Currencies back testing plan to back test a system. You can do it
manually, which can be a drawn out and labour intensive process, or you
can do it with the aid of some software packages. Unfortunately, I
recommend you do it by hand when you first start out. You`ll get a much
better feel for your system, and you`ll understand exactly how using a
Day Trading, Forex or Currencies back testing plan works in all its
intricacies. Once you have the Day Trading, Forex or Currencies back
testing plan and the in depth knowledge, you could look at finding a
software package that does it for you.
There are a few major statistics on your Day Trading, Forex or
Currencies back testing plan that you need that you will uncover
through back testing. The first statistic you need to become familiar
with is the R multiple principal. R stands for risk, the risk you take
on any trade when you enter the market. The R multiple of a trade is
the ratio of the profit or loss compared to the amount of money risked
to make the profit or loss.
Therefore, if you risk $200 dollars in your initial purchase,
and you make a profit of $1,000, you have made five times the amount
you risked in the trade. You have an R multiple of five. This statistic
gives you a good idea of the relative size of your profits to your
losses. You can compare the average size of your winning trades with
the average size of your losing trades.
The next statistic you`ll find useful is your win to loss
ratio. This is how many times you get a winning trade in proportion to
how many times you get a losing trade. For example, if you had ten
trades, four of those trades were winners, and six were losers, your
win to loss ratio is simply four to six. This is your hit rate; you`ll
get 40% of your trades correct.
With these two simple statistics, you can calculate the
average size of your profits and of your losses, multiply these figures
with your win to loss ratio, and calculate on average how much money
you make with every dollar you risk.
For those of you who think this sounds like a too much work,
particularly using a Day Trading, Forex or Currencies back testing plan
that you need to do to uncover these statistics, consider this
scenario: Imagine yourself trading a system that you knew had a win to
loss ratio of 60/40. You made profit on every six trades and lost one
out of every four. How do you think you would feel, where would your
confidence level be, after you traded the system for a little while and
you received a string of 11 losses in a row?
Now, you know that this system has a win to loss ratio of six
to four. Would you have the confidence to open another trade if your
system brought up another buy signal after getting 11 trades wrong?
Unless you use Day Trading, Forex or Currencies back testing
plan to back tested your system, I doubt that your confidence level
will remain high. That trading system may be a fantastic profitable
system. However, since you didn`t use your Day Trading, Forex or
Currencies back testing plan to back test it, you don`t know that
historically this system received up to 13 losses in a row, but was
Here`s another point you may not have picked up unless you
used your Day Trading, Forex or Currencies back testing plan. Once
you`ve set your money management rules and you begin to trade, you will
likely experience a string of losses. Countless times, I`ve had clients
who get disheartened by this fact because they don`t understand the
nature of setting good management. If you`re adhering to the rules of
cutting your losses short and letting your profits run, because you`re
cutting your losses short, those trades are going to last for a shorter
amount of time.
This means once you begin trading the odds of getting losses
early in the game are much higher than getting a winning trade. This is
particularly true when you consider that many successful trading
systems run on a 40/60 win to loss ratio. However, you will never know
the intricacies of your system unless you use a Day Trading, Forex or
Currencies back testing plan and back test it.
Using a Day Trading, Forex or Currencies back testing plan,
will help you to understand what works and what doesn`t. It will give
you the statistics to gauge the effectiveness of your trades. It fills
in your scorecard, and allows you to make improvements. But, you
shouldn`t simply believe everything I`ve told you. Instead, you need to
prove it to yourself by using some Day Trading, Forex or Currencies
back testing plans and back test your system.
by David Jenyns