Tagged: MFE

Overview of the popular metrics that traders look at

Total net profit

Many beginner traders look at this statistic to determine if a trading strategy is tradable. However, this figure is pretty useless on its own. It doesn’t take into account the risk that was assumed in order to achieve this figure. For example, strategy A achieves a total net profit of $80,000 with a max drawdown of $50,000 while strategy B achieves a total net profit of $60,000 and only a max drawdown of $10,000. Should you choose strategy A simply because it has a higher historical profit? What if the drawdown took place at the beginning of the trading period or when you don’t have $50,000 in the first place to survive and continue trading?

Another issue is the distribution of the winners and losers. I would never trade a system that makes its money over a short period of time or over a very small number of trades. These outlier trades may not happen again. A volatile currency pair or stock will also reduce the amount of leverage you can utilize and require a larger initial capital.

Comparing 2 strategies with different levels of volatility.
Comparing 2 strategies with different levels of volatility. I will trade Strategy B over A all the time.

Profit factor

Profit factor can be easily calculated by dividing your total gross profit by your total gross loss. For example, a strategy that makes $100,000 on all the winning trades and lost $80,000 in total for all the losing trades. The profit factor will be 100/80 or 1.25.

A profit factor of 1.2 to 1.5 is desirable.

Maximum Favorable Excursion (MFE) and MAE Maximum Adverse Excursion (MAE)

MFE refers to the maximum profit a trade had before it was closed. MAE, on the other hand, refers to the maximum loss that a trade had before it was closed. If MFE is very high compared to realized profits, that means you trading system had left too much profit on the table and a more aggressive method of trailing and locking your profits might be needed. On the other hand, if MFE is too large, you might be assuming too much risk with your trading. It will be prudent to reduce your trading size.

Maximum consecutive winners and losers

How long a string of winners or losers are does not affect your profitability directly. However, it is an important psychological factor that might affect your trading discipline. For example, a trading strategy that sometimes has 10 losers in a row might prove too much for a trader that can only tolerate at most 5 consecutive losses. He/she might lose confidence in the trading system and fail to take all trades, or attempt to trade a less than optimal trading size.

Trade frequency

This is determined by the number of trades taken and the holding period of each trade. A trading system that trades frequently and exited quickly will need to be more profitable than another which trades less frequently and which holds the positions open for longer. This is because, the more you trade, the more transaction costs you incur.

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