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:
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