How Do You Stack up Against Other Traders? (Part 2)

07/28/2009 12:01 am EST

Focus: STRATEGIES

Timothy Morge

President, MarketGeometry.com

As we look at Albert's second month of statistics, keep in mind that he had already taken my Market Maps basic seminar and had spent a good deal of time actively asking questions and showing his charts in the free MarketGeometry.com trading forum and getting constructive comments from the forum members. His trading had already improved a great deal before month two of mentoring, and you can see that he had a nice, profitable trading month.

But there are some obvious flaws in the his second month of trading:

  1. His largest losing trade is larger than his largest winning trade
  2. His risk/reward ratio is a bit low for my taste, but note that he trades, on average, about six or seven times a day. He also takes quick profits, so the size of his maximum draw down is a real concern. If he isn't playing for a large profit on a regular basis, he cannot allow himself to have a loss this large, unless it was an aberration caused by news or an extremely poor fill by his broker.

Now look at the next month in his statistics. His largest winning trade is considerably larger than his largest losing trade, and that's a very important step forward. He did make a smaller amount of money in month three and his winning percentage was lower as well, but those numbers fluctuate with market conditions and available trading opportunities.

The other big change from month two to month three was his risk/reward ratio, which climbed from 0.75 to 1.71. There are good things going on here! The higher the risk reward ratio, the easier it is to keep trading when you lose a few in a row, because if you hit an “average” winner, it will pay for more than one loser. If your risk actual or realized risk/reward ratio is 3:1, for example, one average-sized win will cover three average-sized losers. I call this “rolling forward” loss coverage—hit a few average-sized winners in a row and you have paid for four, five, or maybe even six losers if you hit a rough patch.

Here's the importance of keeping monthly detailed statistics: If he had merely looked at his net profit, he would have come to the conclusion that the first month was much better than the second month, and in my opinion, nothing could be farther from the truth, even though I do believe in looking at net profits. To become a consistently profitable trader, you have to depend on having a reliable, quality risk/reward ratio, have your maximum losses under control, and have your largest winners consistently larger than your losers. The statistics tell you what you can realistically expect going forward.

Let's look at a trader who is just starting out. Bobby had been trading for about nine months before he read one of my articles on MoneyShow.com. He must have liked what he read, because he e-mailed me, saying he had read every article archived at MoneyShow.com and wanted to know what else he could do to become a consistently profitable trader. We discussed his background and he showed me the results of his nine months of trading on his own. I suggested he either attend the next Market Maps basic seminar, because it would give him a firm foundation in money management and risk/reward ratios, as well as show him a trading methodology he might or might not like. He was currently using three or four indicators and trying to trade ten or eleven cash currency markets using mini-sized cash contracts.

He took the basic seminar and then attended a free Monday Market Maps pre-market live session, which the CME Group sponsors. After the first live session, he signed up for the subscription-based Tuesday through Friday sessions. After attending them for two months, he signed up for group mentoring. Each of these steps gave him a bit more structure to his education.

Tomorrow in Part 3, we’ll see how it helped his trading performance.
Read Part 1 | Read Part 3 | Read Part 4 | Read Part 5

Timothy Morge

timmorge@gmail.com
www.medianline.com
www.marketgeometry.com

Related Articles on STRATEGIES