Are you maximizing your winners?
Are you minimizing your losers?
You may have said ‘yes' to both questions… but do you know for sure?
Remember, if you don't know exactly how you're doing, you can't possibly get more profitable, because you won't know what to fix.
First things first: your first step in improving your trading results is to figure out your batting average and your Sharpe Ratio.
A batting average is exactly what it sounds like — the percentage of your trades that make money.
Your Sharpe Ratio is your average winner divided by your average loser. If your Sharpe Ratio is above 1, your average win is bigger than your average loss. And if it is below 1, your average loss is bigger than your average win.
Let's work through some examples.
To keep things simple, we're going to use 3 trades with the following results
Trade 1 = -$100
Trade 2 = -$100
Trade 3 = +$300
So we have 2 trades with a loss of -$100 each and 1 trade with a profit of $300.
Our total Profit/Loss is +100.
Since 1 of 3 trades make money, our batting average is 33%.
Our Sharpe Ratio is 3. This is calculated as $300 (our average gain) divided by $100 (our average loss). $300/$100 = 3
Profit/Loss = +100; Batting Average = 33%; Sharpe Ratio = 3
Most new or struggling trader have a Batting Average under 50% and a Sharpe Ratio below 1.
This mean the following:
A low batting average is often the result of flawed strategies or inconsistent management.
This is common for traders that don't have a solid educational foundation in trading.
A sub-1 Sharpe Ratio is often easier to diagnose and treat.
It's very common for some traders to get out of winners too early, and out of losers too late.
They usually do one of these 2 things, or both:
So how can you improve your Sharp Ratio?
I suggest tracking 3 stats over time so you can figure out where you're going wrong, and make corrections:
1. Capture % (Actual Profit/Max Profit)
Your Capture % is the the Actual Profit on your trade, divided by the Max Profit possible on the day of your exit.
This will tell you how much of the potential move you captured.
Let's say we bought Apple (AAPL) at $160.
If we sell at $163 ($3 Actual Profit), but the stock hits a high of $166 ($6 Max Profit) later that same day, we have a Capture % of 50%.
$3 divided by $6 = 50%.
It is impossible to maintain a 100% capture rate. But if you are consistently below 50%, then you know you are capturing less than half your potential gains.
2. Aim % (Target Profit/Max Profit)
Most of your trades should have target or targets identified prior to entry.
Tracking your Aim % will help identify if you are being too ambitious or conservative with targets.
We calculate Aim % by taking our Target Profit and dividing it by the Max Profit.
Let's assume we're in Amazon.com (AMZN) from $1,000 and we are targeting a move to $1,050 for a $50 profit.
If the stock instead hits $1,060, the max profit is $60.
$50 divided by $60 equals 83%.
This is actually a very good number, because it shows we set a fairly accurate target.
3. Management % (Actual Profit/Target Profit)
Your Management % will tell you if you are overmanaging your trades.
We get this number by taking our Actual Profit on a trade divided by our Target Profit.
Assume we buy Nvidia (NVDA) at $200 with a $210 target.
If we sell at $205 for a $5 profit, our Management % is 50%. ($5 divided by $10)
If this number is below 100%, then you may benefit from an All-or-Nothing approach. Let your trade work to its target, or stop out. Do nothing in-between.
This will help you respect your targets.
Calculate these stats regularly, and review them at least once a month.
If your numbers are rising, then you're moving in the right direction.
You're putting more money in your pocket, and leaving less on the table.
But if your numbers are falling, slow down and figure out where you're going wrong.
If you would like to improve your trading consistency, and generate steady profits, we highly recommend looking at The Turnaround Trader Formula — a new program designed to take you from negative to positive.