This is intended to be a guide for traders looking at existing trading systems, or traders wanting to evaluate their own trading systems. I hope you find this valuable. I have used this information for the last 2 years, and I have found it tremendously useful.<o
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A Need for System Statistics<o></o>
When talking about trading systems, there exists a fundamental need to represent their performance in a way that is comparable. A trader must be able to evaluate a trading system to determine if this system (a) produces acceptable returns and (b) has an acceptable risk threshold. It is possible to have a wildly profitable trading system, but puts 100% of the capital at risk. Luckily for us, there are some very useful statistical formulae which can sum this information up nicely for us. These formulae are flexible enough to be able to compare 2 trading systems with very different characteristics, so we can make an informed decision regarding the two. In this essay, I will walk us through an analysis of the Firebird EA, because it has been very popular recently. In this example, I will focus on the EUR/USD pair, because this EA uses different settings for different currencies.<o></o> Basic profitability is the first attribute we will discuss.<o></o>
Risk and Reward<o></o>
The first 2 ingredients to computing expected return is to evaluate risk and reward. To put this most simply, reward is the average magnitude of the win, and risk is the average magnitude of the loss. The rate of these events will be discussed separately. These usually correspond to the take profit (t/p) and stop loss (s/l) of each trade. If the t/p and s/l are different for each trade, then the t/p values must be averaged over all completed trades (the same is done for stop losses). Some automated Expert Advisors (EAs) in MT4 have fixed t/p and s/l levels coded in, so these values may be easy to find. It is useful to look at these two values as a ratio; the risk/reward ratio. Trading systems with low risk/reward ratios aren't bad per se, they just require some special attention (later in the next section). It should also be apparent that the greater number of trades used to calculate these averages, the more accurate the averages will be. Having only 3 or 4 trades using a system will not give very representative numbers, so every attempt should be made to either make or simulate more trades. For systems which can be backtested, either in MT4 or elsewhere, average values calculated as above will give us what we want, if the t/p and s/l values are not constant in the system.<o></o><o></o>
Calculating risk/reward for Firebird is easy. There is a fixed t/p level of 22, and a s/l of 220. Risk/reward is 10/1, and is worthy of comment. On the face of it, this appears a very low number. Could a system with this risk/reward ratio be profitable? The next analyses will tell us for sure.<o></o>
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></o>A Need for System Statistics<o
></o>When talking about trading systems, there exists a fundamental need to represent their performance in a way that is comparable. A trader must be able to evaluate a trading system to determine if this system (a) produces acceptable returns and (b) has an acceptable risk threshold. It is possible to have a wildly profitable trading system, but puts 100% of the capital at risk. Luckily for us, there are some very useful statistical formulae which can sum this information up nicely for us. These formulae are flexible enough to be able to compare 2 trading systems with very different characteristics, so we can make an informed decision regarding the two. In this essay, I will walk us through an analysis of the Firebird EA, because it has been very popular recently. In this example, I will focus on the EUR/USD pair, because this EA uses different settings for different currencies.<o
></o> Basic profitability is the first attribute we will discuss.<o></o>Risk and Reward<o
></o>The first 2 ingredients to computing expected return is to evaluate risk and reward. To put this most simply, reward is the average magnitude of the win, and risk is the average magnitude of the loss. The rate of these events will be discussed separately. These usually correspond to the take profit (t/p) and stop loss (s/l) of each trade. If the t/p and s/l are different for each trade, then the t/p values must be averaged over all completed trades (the same is done for stop losses). Some automated Expert Advisors (EAs) in MT4 have fixed t/p and s/l levels coded in, so these values may be easy to find. It is useful to look at these two values as a ratio; the risk/reward ratio. Trading systems with low risk/reward ratios aren't bad per se, they just require some special attention (later in the next section). It should also be apparent that the greater number of trades used to calculate these averages, the more accurate the averages will be. Having only 3 or 4 trades using a system will not give very representative numbers, so every attempt should be made to either make or simulate more trades. For systems which can be backtested, either in MT4 or elsewhere, average values calculated as above will give us what we want, if the t/p and s/l values are not constant in the system.<o
></o><o></o>Calculating risk/reward for Firebird is easy. There is a fixed t/p level of 22, and a s/l of 220. Risk/reward is 10/1, and is worthy of comment. On the face of it, this appears a very low number. Could a system with this risk/reward ratio be profitable? The next analyses will tell us for sure.<o
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