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“A trading journal keeps you constructive, keeps you learning, and keeps you working on the things that are most important. It is not a tool for simply rehashing the day; it is a tool for self-development.” - Brett Steenbarger, Ph.D.
This article stems from a recurring issue that seems to appear when traders start to pay attention to their statistics. There comes a time when a trader is becoming consistent to a certain extent and starts to shift his objective from "making money" to "making good risk-adjusted returns". At this point, many traders start to put pressure on themselves, seeking to reach certain performance objectives (for example an Average Win/Average Loss ratio of 2) in isolation.
The net result is, usually, poor performance and a dose of frustration to top it all off.
So let's cut through these issues.
What Came First: The Trading Process or The Statistics?
Yes, it's important to track your statistics.
Yes, it's important to produce good risk-adjusted returns.
But your statistics are a function of your entire trading process, which is a sum of good habits. Just like your annual blood analysis tells you how functional your day to day living habits are, your trading statistics tell you how functional your day to day trading habits are.
The focus must always be on the PROCESS. The PROCESS creates the statistics, not the other way around. Here's a good example that explains some of the mental traps that will appear if you start to lean on our trade statistics instead of your process.
One trader I worked with had this issue: I’m worried about the pace of my progress. It has been much slower than expected. How can I speed up the process going from say 2 trades/ week to 20 trades/week without completely deviating from the system I've built?
This trader had recently reached consistency and his equity curve was moving upwards. But he was only getting 2 opportunities per week, on average. The trader wants to take more trades, because he knows that a higher trade frequency means potentially more frequent profits.
It goes back to expectancy formula:
(Average profit per winning trade)* (% winning trades) – (Average loss per losing trade)*(% losing trades)
Here’s a realistic expectancy calculation:
($300 x 50%) – ($150 x 50%) = $150 – $75= $75
Breaking it down:
50% Win Rate
Avg Profit/Avg Loss = 2
The expectancy formula above indicates you had 50% winning trades and each gained $300 on average, with 50% of total trades being losers but at a cost of $150 each on average. Your expectancy for the next trade is a net $75. The expectancy is positive, but we also need to take into consideration how much capital we’re using, and over how many trades we can obtain that result.
If you are trading only once per month, in one year you might have a high probability of making 12 x $75= $1170, which is a great return on a $5000 account, a decent return on a $10000 account, but it still may not fit your goals. Here's the equation you want:
Capital Goal = Starting Capital + (Expectancy * Total Number of Trades)
Let’s say you have $10,000 worth of risk capital and you want to make a healthy 25% return this year. Here’s how you rework the equation:
$12500 (goal) = 10000 (starting capital) + [$75 (expectancy)*number of trades]
You would have to make 33 trades per year in order to reach your goal, which is almost triple what you are actually achieving (12/yr in the example). And this is what was worrying the coachee: he felt that he wouldn't meet his financial goals fast enough.
Here’s the key: the expectancy equation makes us feel in control of our financial destiny because we can invert the equation and find out exactly what we need to do, in order to reach our goals. However this is a false certainty. All the numbers used in the equation are based on a past performance, exploiting your trading process. So be very careful: you cannot force anything upon the market, and need to wait for the market to display the right conditions for your model.
Focus on the process, trade well, and your numbers will look good. Focus on the numbers, trying to push the limits of your model, and your numbers will start to look worse.
Going back to this coachee, the issue was in his confidence. He simply wasn't exploiting all the opportunities his trading process was offering him each week. So if you're worried about your trade frequency, try answering the following questions:
are you identifying all the top-quality opportunities the market is presenting to you each week? Or are you skipping them? If so, why are you skipping them? Is it a subjective matter? Or is there a recurring theme, a common denominator that can help you identify your trade setups even better?
if your filtering is good, are you getting into the trades via simple triggers? Or are you finding it difficult to execute for some reason? What can you do to overcome this issue? Are you trading too big? Is the trigger too complex?
Here is a chart from a student of mine that went through the coaching process with me. It’s an excellent example of what is possible (over the course of two months) if you focus on the process, filter quality situations, know when to sit on your hands, and cut losses at the knees.
You really can undermine your own success, and ruin a viable trading model, if you let yourself get distracted. That’ exactly what was happening to the coachee in question. In his own words:
I’m worried about the pace of my progress. (fear of failure)
How can I speed up the process? (focusing on the money)
Don’t ruin a good trading model by succumbing to mental traps. Be disciplined and be scientific with your understanding of the trading model you use. Only by “working with it” can you get to understand it inside out and thus enhance your confidence.
Taking the Vital Signs of Your Trading Process
If I were to ask you what has been working in your trading, and what has not, would you be able to give me a clear, demonstrable answer? Keeping a detailed trading journal is possibly the only way to have clear answers about any aspect of your trading and your performance as a trader.
I have yet to meet a consistent trader that does not keep good records. Without capturing on the trades you have placed, you will likely struggle to remember what you did well, and spot potential behavioural patterns that need improving.
Keeping good records allows you to spot right away where your problems are. For example, at a certain point of my career, I had a tremendous win/loss ratio but I was losing money. My journal told me what I was doing wrong: cutting winners at their knees. My journal also told me what I was doing right: cutting losses equally fast. My journal told me my average win, which was half that of my average loss. So already, I had information to incorporate into my future trading habits to turn things around.
The basic canvas of a Trade Blotter
There are many automated ways to keep a journal nowadays (MyFXBook, TraderVue, Trademetria, etc.) but by inserting the data by hand you do get a better feel for the numbers and what they mean.
Earlier in the article we briefly compared your trading statistics to your blood analysis. Here are the "vital signs" that I would suggest monitoring and reviewing every 20-30 trades:
N° Trades: How many trades you have taken (and if you divide this by 252 trading days in a year, you will know how many trades you take per day, on average).
%Win: How many winning trades you have. Long-term, it's very difficult to achieve more than 50-55% with proper trade management practices. I would suggest detaching yourself from the win rate and instead focus on ensuring your gains are much larger than your losses. If your average win is much larger than your average loss, you don't need a high win rate in order to remain profitable.
%Loss: The opposite of the win rate. Evidently, having a lower amount of losses is easier on the mind, but traders who focus on maintaining a high win rate usually suffer larger drawdowns and have an insufficient average win/average loss ratio.
Longest Winning Streak: count the longest streak of winning trades not interrupted by a loss.
Longest Losing streak: this is a potential measure of your Drawdown. As a rule of thumb, double your longest losing streak in order to have a more sensible long-term expectation of what is possible. For example, if your longest losing streak is 5 trades, then it's likely that in the next year or two you will have 10 losses in a row. This is important because the #1 priority for a trader is to keep losses and drawdowns at reasonable levels. If you are risking 1% of your equity on each trade, 10 losses makes a large dent in your account. So you might want to do a bit of quick math:
Max Loss Count = 5
Realistic Max Losses = Max Loss Count * 2 = 10
Maximum Tolerable Drawdown of Trading Capital = 3% (a decent measure)
Maximum risk per trade allowed = 3%/10 = 0.3% of equity
So if you have a £10.000 in your account, you would use 10.000*0.003 = £ 30 per trade.
Risk per Trade: how much you are going to risk on each trade. I like to keep this value constant as a % of my equity. Knowing off the bat how much money I’m risking allows me to calculate the position size, based on the number of pips between my entry and my stop loss.
Avg. Win: (Sum the values in the %R column if they are positive)/(Count the values in %R column if they are positive).
Avg. Loss: (Sum the values in the %R column if they are negative)/(Count the values in the %R column if they are negative)
Return Quality = Standard deviation of the returns in R-Terms. The R-multiple is simply the distance between your entry and your stop loss.
Expectancy = (%Win * Avg. Win) -absolute value of (%Loss*Avg. Loss), which should be above 0.5
Expectation (or Opportunity) = Expectancy * n° trades/day = avg. Daily expected win/loss in terms of R
System quality = Expectation/ Return Quality, which should be above 0.5
How to Incorporate This Information Into Your Trading Process
Each year, it's best to do at least 1 blood analysis, a checkup to see how you're doing. Let's imagine I have blood sugar and cholesterol levels that are too high. What do I need to do?
Do I need to eat less? Do I need to move more? Perhaps not...perhaps I'm eating very little but eating poorly. Or perhaps I'm eating well but drinking too much. Perhaps I'm walking every day but I'm also very sedentary. There can be many different permutations if we look at the single components that can cause high blood sugar and high cholesterol levels.
The ONLY way to use that information properly, based on my own experience, is to take it all back to the PROCESS (i.e. the day-to-day activities that allow me to move towards my goal of getting the blood analysis back into proper parameters) and ensure the PROCESS is SUSTAINABLE LONG-TERM (ie. it's a change in lifestyle, not a short-term deviation that's so strict I can't wait to end it!)
So in the same way, trading statistics (Avg win/Avg loss ratio, Sharpe Ratio, etc) are your blood report. It's useless to focus on them every trade, every day, every week even. They are a guide that tells you how your PROCESS is performing. If you need to change something, you need to fall back on the PROCESS and make SUSTAINABLE changes that are logical and are backed up by proof.
Blood analysis will tell you what you need to change in terms of day to day habits.
Trading stats will tell you what you need to change in terms of day to day trading habits.
Q: Am I cutting my winners short?
To answer this question, look at your average gain/average loss ratio. If your gains are approximately the same size as your losses, you need to work on improving this.
Start by thinking about your plan: what was your initial objective for the trade? Was it meant to be a swing trade that you transformed into a day trade? Was it a day trade that you were hoping to roll over into a swing trade? Why did you exit the trade?
These questions can be answered if you keep track of the “passive management” test: what would have happened if you did not actively manage the trade? If you can get better results by simply applying a “set & forget” method, then do so.
Also, it can straighten your mindset. You may think you’re getting out of trades early because you’re scared. But really, it’s a product of not reviewing your records and finding out exactly what happens in the majority of your trades when you manage actively and when you sit tight. So using your journal, you can find out why you get out too early.
Q: How much of my Maximum Favourable Excursion am I capturing?
Are you giving up a good portion of Maximum Favourable Excursion (MFE)? Get back to the drawing board and find a way to incorporate this into your trade management plan. Would you have been better off using a trailing your stop? And on what time frame? Upon which considerations? This is all hard work…but it’s worth it.
Q: Can I limit my Maximum Adverse Excursion?
How far do your winning trades go against you before they go in your favour? If you trade from the same angle for any length of time, you’ll notice a pattern. Your journal will capture that pattern for you and will be able to say whether 20 pips is your average MAE…or 10 pips…or 50 pips for larger moves or more volatile pairs. And remember: the efficiency of your entries will need work if you suffer intratrade drawdowns that are as large as your win. The less the trade goes offside before trotting along to target, the more efficient an entry system you have.
Let’s put this into perspective: if your timing is good and you realize that your trades have an average MAE of 30 pips, and you are currently using 70 pip stops, then you can use a tighter stop, which will allow you to raise your position size! Your winning percentage will probably drop a little, but if you’re consistent, your expectancy should rise a lot.
Q: How can I lose less?
Is there a common denominator linking together your losses?
Are you trying to “move stop to breakeven” too soon? Most likely you are trading your equity and not the market movement.
Are you trying to squeeze too much juice out of them, rolling over every trade? Unfortunately, you can’t expect each trade to be a runner. So pay attention to the clues the market drops you!
Are you trying to pick market turns? Fading trends is generally a high risk endeavour. If anything, stops on contrarian strategies should be very tight.
Are you adopting some indicator to time your entries?
Are you not considering scratching your trades at some point? Or are you simply not following your own rules? Are there certain days of the week (like Mondays or Fridays) that seem to produce constant losses?
Whatever the issue, use the journal to identify it and fix it.
Over to You
Create your own trading journal on Microsoft Excel and take 30 trades in a consistent manner:
· use the same entry tactic
· use the same exit tactic
· use the same position size
and record your statistics in your trading journal.
What do you notice?
What sticks out like a sore thumb?
What needs work?
If you have any questions, just get in touch!
Very informative and useful post! Thank you