Saturday, March 08, 2014

Trading efficiency

In his book Super Trader, Van Tharp talks about trading efficiency as a means to track how effective a trader is in operating and following their trading system.

A trader can potentially turn a winning system into a losing one, by not being very efficient in following their system rules or parameters.

These mistakes or trading errors can be any of the following:
  • Trading too large or too small a position, based on your risk per trade parameters;
  • Taking on too many positions, exceeding their overall risk parameters;
  • Not taking a signal that matches your criteria;
  • Taking profits too early, for fear of losing them, before an exit signal is given;
  • Taking an entry signal that doesn't match your criteria.
Van Tharp recommends keeping a record of any such mistakes, and quantifying them in terms of R.

The closer to 100% efficiency a trader can get, then in theory the better his performance. Just a small increase in efficiency can yield a significant improvement in results.

This is an excellent concept, and can quickly show a trader how, by deviating from his trading plan, mistakes can determine their ultimate success or failure. This should form part of a regular review of your own trading, and your ability to adhere to your chosen approach.

Take for example a trader who trades a small basket of stocks or commodities. He has a low win rate, but those winning trades are far bigger than the size of his losing trades. This combination gives him an overall positive expectancy. It is therefore imperative that he takes all the signals his system generates. If not, then he could miss the single most profitable trade for the year!

If that did indeed happen, he may have taken 99 out of 100 signals generated. But he may have ended up with a loss for the year. He achieved 99% efficiency, based on the number of trades in which he was able to follow his system rules. But when his efficiency in quantified in terms of R, he would find he has a much lower percentage.That one missed trade would have turned his whole performance round.

Now, that perhaps is an extreme example, but it can and does happen. To improve his efficiency, that trader would need to ensure that he has systems and procedures in place so that all generated signals are acted upon, come what may. This may mean re-scheduling his work day, prioritising certain tasks, or perhaps automating his trading strategy.

Failure to put these procedures or steps in place will continue to result in lost opportunities or profits. The fact that the system generated an opportunity, but the trader did not act upon it, is not the fault of the system, or the markets. It's the fault of the trader. In other words, he needs to take full responsibility for his actions (or lack of) when it comes to his trading.

As Van Tharp says in Super Trader "YOU are the most important factor in your trading. It's not your system because YOU both produce and execute your system. It's not your position sizing strategies because YOU must execute the proper position sizing algorithm to produce YOUR results to meet YOUR objectives. And it's not the market because you don't really trade the market. YOU trade YOUR BELIEFS about the market."

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