Measuring the Performance of a Forex Trading Strategy

Measuring the performance of a forex trading strategy is very important for various reasons. It is vital to stay true to the chosen forex strategy or forex system until it is proven that it does not work. Additionally, it is only advised to make change when it is necessary despite the fact that strategies and systems should adapt to changing markets.

Of course one can say that it is really easy to measure a strategy as you only have to check how the account size changes. If it diminishes then you should make changes but when it goes up then the strategy or the forex system works. Although this can definitely be a way of measuring a strategy but this method is really far from grasping the big picture and is giving a raw performance estimation rather than a detailed overview. Additionally, it takes minimum 100 trades to be able to form some kind of a statistically backed up result on the system or strategy. On the other, when the 100 trades are carried out it can be used for further analysis in the effort to get a detailed overview on the performance that allows the highlight of the elements that needs to be changed.

So how should be such a performance measuring done?

1. Calculating the Hit Ratio

Calculating the hit ratio of a forex trading strategy is the easiest among all. It basically gives the probability of a winning trade in percentages. It is calculated by dividing the number of winning trades with the number of overall trades (number of winning trade/number of overall trades). Although, the hit ratio has a vital a take on the performance of any forex systems or trading strategies, its importance is rather overvalued as it is only a part of the equation. Read more about this in The Secret about Hit Ratio.

2. Calculating the Payoff Ratio

The payoff ratio of a forex trading strategy is the other, little known part of the equation. This basically shows whether a strategy is profitable on the long run or not.

To be able to see clearly how much the strategy is profitable a minimum payoff ratio has to be calculated. This is done by dividing the number of losing trades by the number of winning trades.

As soon as we get the minimum payoff ratio the actual payoff ratio has to be calculated. It is calculated by dividing the size of average winning by the size of average losses.

If the actual payoff ratio is smaller than the minimum payoff ratio then the trader needs to apply changes in order to stay in business on the long run. However, when the actual payoff ratio is bigger than the minimum payoff ratio than the trader operates a profitable business on the long run.

The bigger the actual payoff ratio the more profitable the forex trading strategy or the forex system is.

3. Calculating the Expected Value

In case of any forex trading strategies the expectation is to have a positive expected value. If the expected value is in the negative territories then this means that operating the current version of the trading strategy or the forex system is not a profitable business and it leads to bankruptcy in the long term. The way to calculate the expected value is the following: (hit ratio × average winnings) – (% of losing trades × average losses)

This formula perfectly shows the close relationship between the hit ratio and the payoff ratio and shows how they influence the profitability of the forex trading strategy or system. The higher the hit ratio and/or the average winnings the more profitable trading becomes while the chance to go bankrupt increases as these numbers turn lower.

It is unfortunate that one cannot effectively increase the hit ratio without decreasing the payoff ratio in reality. Further details on this unfortunate situation can be read in Forex Trading Systems: Hit Ratio Vs. Payoff Ratio.

Final Thoughts about the Performance of a Forex Trading Strategy

Although these calculations are inevitable to see the performance of any forex trading strategy, I advocate that it is better to make these calculations based on your own trades in order to see how it works for you. The human factors, the different level of experience and patience of the trader, the ever changing market circumstances, the different time zones and currency pairs together ensure that these performance measures will keep on changing continuously. That is why we decline to hype our product, the Stealth Forex Trading System™ with misleading historic results.