Consistency: the Measure of Success

Discussion in 'Trading' started by Raystonn, Aug 30, 2006.

  1. How many of you are impressed when you see someone has won a certified, audited, trading competition by achieving 200% profits for the year? Would you be impressed if it was 1000% instead? If you absolutely could rely on the certification and audit and the trades really did take place, would this impress you?

    It shouldn't.

    The trading results for those without an edge tend to follow a bell curve distribution. Most sit near the center with small losses due to commissions and fees. Many sit on either side of the center line, making some and losing some. Very few and far between are the outliers. There will always be a #1 in a trading competition and, given the way rankings are currently computed, (by net profit alone) this winner is virtually guaranteed to be an outlier. Is this due to some kind of skill? That is unlikely. The outliers of the bell curve, based purely on luck with no real edge, will nearly always beat the net profit delivered by someone with an actual edge. Just as a lottery winner would be on the top of such a list, the lucky but not necessarily skillful will also be on top.

    When evaluating the best trader, Net Profit is not the best measurement. A much better measurement would be the smoothness and slope of his/her equity curve, the maximum peak-to-peak drawdown, and the consistency of his/her placing well in the competition.

    Next time someone flashes you impressive stats, even accompanied by audited results, try not to be too impressed. If they are any good they will be able to repeat that performance in the future. Otherwise, just dismiss it as luck. The trader won the market version of the lottery. Congratulate him or her... but try to keep the hero worship to a minimum.

  2. What time-frame would you use to gauge consitency then? 5-years? 10-years? You've just cut out the majority of funds as "lucky".

    What about variation in the account? What is too much? +/-10%? +/-25?
  3. A decent, but not infallible, measurement would be Profit Factor. This value is the profit generated by profitable trades divided by the losses generated by losing trades. A value of 2.00 would indicate that twice as much money was made from winning trades than was lost from losing trades. Higher values usually indicate less risk.

    But this alone is not enough. You must analyze the maximum peak-to-peak drawdown and look at the equity curve. You want a fairly steady increase in equity without a huge amount of risk being taken. You wouldn't want to invest your money in some fund where the manager dumped all the money into a single stock last year and got lucky, would you? What are the odds of this repeating? Not good. Even if this was done a few years in a row, this may still be luck.

    If you begin with 1024 fund manager and each year half of them gets a random stock call correct, after year 1 you would have 512 lucky fund managers. After year 2 you would have 256 lucky fund managers. After year 3 you would have 128 lucky fund managers. After year 4 you have 64 lucky fund managers. After year 5 you have 32 lucky fund managers, etc. These latter fund managers have a great track record on paper, but did nothing but flip a coin. Their success is pure luck. Nobody focuses on the fund managers that have done poorly.

    In fact, fund managers have gotten a bit smarter now. They start multiple funds. When one dies, it is discontinued. Eventually they are left with one that looks like it has a great track record. But in reality it is still alive merely out of luck. And this is the fund everyone rushes to invest in. And then the investors are left wondering why the returns soured the moment they invested.

    Be careful...

  4. OK.

    I have a choice of being a trader who:
    - makes $150 avg per day consistently (max 175, min 125); or
    - makes $10,000 avg per day inconsistently (max 20,000, min -10,000)

    I'm going to have the guts to assume the risk and be the second trader. Its one thing to look at the stats that are appropriate to a fund where half of the "investors" are nervous nellys ... but for freaks sake - are we traders or nellys?
  5. Raystonn,

    your view of how it works is way off the mark.
  6. Your strategy listed as inconsistent is actually highly consistent. An inconsistent strategy would result in a 1000% profit one year and a disastrous wipeout the next. No reasonable trader would use such a risky strategy.

    As far as being off the mark, please state where. Nothing I have said so far has been an opinion. It's all fact.

  7. Cheese


    The few big private players royally amassing money from market trading, eschew public displays.

    Incidentally there is no 'edge' and certainly not any as a means to take all the money from the markets using the trading day's entire menu. Apart from anything else, you have to learn and know intimately your market, to utilize every trading session, beginning to EOD.
  8. Ok, sounds like you've got two measurements:

    1. profit-factor is total gains to losses. Of course any account that's in the positive will have a profit-factor over 1.0. I like a 2.0 at least as well.

    2. peak-to-peak drawdown to equity. What ratio of equity do you want to the drawdowns to be within? 10%? 20%? 30%?

    Because combining both these factors may result in some contradictions and paradoxes. With a $100k account for example:

    1. profit-factor = 2.0 This can come from +200k/-100k for an increase to $200k. But PF=2 can also mean +2/-1 as well to $100,001

    2. peak-to-peak drawdown to equity may equal 50%? Let's say he bets $50k and loses, then bets another $50k and makes $150k ($100k profit). This meets the 1st profit-factor=2, but seems risky.

    What about risking 33%? Bets $33k down and loses. Bets another $33k and wins $99k. Same 2.0 profit-factor as before. But still seems risky to me.

    What's the % of equity at risk that's acceptable for you? Also you haven't mentioned anything about time-frame. You want someone to do this performance for 6-months? 1-year? 2-years? 10-years? At what time-frame do you consider them to be a "consistent" and "good" trader?

    The guy that made 1000% one year and loses 50% of that the next is still up 500% overall for a profit-factor of 5.0, well over your minimum standards. What if he then makes 2000% on top of that the next year?

    Sounds like you're trying to make up a lot of measurements and rationalizations to explain something that you don't fully have a grasp on.
  9. More than that really. You need to examine the equity curve. A series of sharp ups and downs means the risk is too high. It's too volatile.

    Ideally, you'd want to run something like a Monte Carlo simulation on the list of trades from a real account. That would give you an idea of the risk involved. Anything less than a few hundred trades doesn't give you enough information to make an assessment.

    I recommend running a Monte Carlo simulation to arrive at a drawdown figure that will occur very rarely. For example, if you achieve a drawdown of 50% of your account only 0.1% of the time, then you might think about increasing your leverage a bit. If you achieve a drawdown of 100% of your account 50% of the time, then you desperately need to decrease your leverage.

    Time frame isn't as important as number of trades. If you run 200 trades through a Monte Carlo simulation, then you can be pretty confident about the next 20 or so trades. Probably even more than that.

  10. Joab


    I have often said:

    The only true professional trader is one that has been in the business for longer then 10 years.

    Markets go in 10 year cycles ... if you can last through 10 years from nothing but "TRADING" income, then and only then are you a professional trader.

    #10     Aug 31, 2006