Adrian Reid walks through how to tell if your trading system is still profitable by watching key metrics: win rate, average win and loss size, profit per trade, and drawdown. He runs daily backtests on his end-of-day stock systems to catch when performance degrades and to generate the next day's signals.
So how do you decide once you've got a set of rules, whether they're still working, whether you can keep using them, or whether you have to change them, refine them, reoptimize them, or throw them away altogether? The answer is really in understanding the statistics, the performance statistics that the system is generating. So when you run a backtest, you get a whole bunch of information. You get number of trades, percentage of winners, percentage of losers, size of wins, size of losses. You get an equity curve which tells you how your account would have grown over time, lots of information. And you can monitor those statistics over time. And if you see your win rate dropping, if you see your average trade profit, profit per trade drop, if you see your drawdown in your equity curve getting bigger over time, these are all warning signs that the system or the rules are no longer working as well as they did. And so once you've got a set of rules, you have to understand how do they perform, what are the statistics that you should expect from those rules? And then you monitor those statistics and check for changes over time. With my systems that I'm running in the stock market, I back test them every day. Now my systems are end of day systems, so I run them once a day. And if I've got a new trade to take, I'll take it at the open, the next open, whether it's a buy or sell, it all happens then at the open, or it could be all at the close, depend on the system.
But I run the backtest every day to both generate my signals and also look at what the system is doing. Because if the system is degrading, I want to watch it every day and just see what's happening.
And you can particularly, the easiest way to tell is by looking at the equity curve. And if the daily changes in the equity curve and the slope of the equity curve over time is deteriorating, then you basically revisit the system and investigate what's happening.
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