Goal / Target Setting and Performance Measurement for Futures Trading

What is the reasonable goal or target of expected return we need to set for ourselves to make taking the higher risk in futures trading worthwhile ?  Everyone has got their own numbers.  How do we grade ourselves?  Everyone has their own way as well.  I'm going to share a quick and dirty way here.

First, we use the leverage in the product that we are trading to set the goal or target of expected return.  Let's take FCPO for example:

The settlement on Friday for most active month (Jan14) was 2401.  Contract multiplier is 25 and the margin (both initial and maintenance) at the moment is RM4500. 

Leverage = actual contract size / initial margin
                = (2401 x 25) / 4500
                = 13.34
Let's round  it to 13.

If we take risk-free rate here as our BNM's OPR at 3% now, then the expected return (goal / target) we should be looking at for taking the risk to speculate in FCPO should be 13 x 3% which is 39% per annum!  Of course that is the ideal target or 100 marks equivalent in our exams.  In actual trading we won't be putting up just the exact initial margin but maybe 2 to 3 times more per contract.  If your trading rules is to put up 2 x the required margin then your expected return would be lower down by half to 19.5% per annum as the leverage is lower by half.  Putting 3x margin would lower down your target to 13% return per annum.  Of course with position sizing algorithm, your return should be higher.  The example shown here is pure basic 1 contract. 

As you can see if your system needs RM30,000 to trade a contract, your expected return becomes 6% which may not be that attractive anymore.  This will be a quick guide for you to search or develop a trading system that gives you a favourable reward to risk ratio.

How do we measure our own performance?  Quick and dirty way would be the same way we grade in exams.  If 50 points is the equivalent of making 3% (risk-free rate) or just pass then we need 80 points and above to get A.  If we use 2x margin per contract, you would need a return of (0.6 x (19.5-3) + 3) = 12.9% and above per annum to get an A!  Of course statistics shown that most traders would get an F which is losing money!  Trading would be one of the most challenging subjects in life to get an A year after year, let alone trying to be an outstanding student which is to beat the target every year.

That's my quick and dirty way to set the target and do self performance measurement in futures trading.  Cheers & Happy Trading!

Blind Faith or Calculated Risk? How Many Consecutive Losses to Expect?

A lot of system traders when develop or looking for a trading system would only want a high win rate or high percentage of winning trades (other than high return) thinking that that is the most important thing and will minimise their losses or drawdowns when trading it.  I am here to tell you not necessary!

Having a high win rate doesn't mean you will never suffer many consecutive losses (which I'll talk about here) or even the trading system will make money in the long term (I'll explain more maybe in future article)! 

But how do I know how many consecutive losses to expect?   I'll show you a quick Excel spreadsheet that I hope would help some traders understand trading edge better.  The example below shows a system with 70% win rate in a 10,000 permutation simulation with their respective numbers and percentage of consecutive win and loss trades.  How many consecutive losses is the maximum in this sample of simulation? 9!!!  Multiply that with your average size of losing trade and you'll roughly get the idea of how much minimum starting capital needed in the trading system (plus margin for the number of lots you are trading if you don't want margin call or intraday force liquidation of your positions). 

How do you know if you'll start with consecutive winnings first or consecutive losses first?  Now who tells you luck is not important in system trading?  Lets say you have bad luck, imagine 6 months to go through max consecutive losses when you start then another 6 months trying to climb back to breakeven, that is 1 full year of pain, I can't blame you from giving up on system trading.

Even a system with 70% win rate you may suffer 9 losses in a row!  What if during actual trading, the win rate drops to 60%? Will your ratio of average win/average loss big enough to still have positive edge? Or the system will go into losses or stop working which is what usually happened as the win rate that we get is usually fully optimised, a drop in win rate when trading live is almost for sure!  What about usual trend-follow system with 30-40% win rate?  Can you still take the next trade after suffer 8th consecutive losses?  Will telling yourself "fear is not real" help??? Talk is always easy.

Here's the sample screen:

Cheers & Happy Trading!

P.S.:  How many max consecutive losses for a system that is 50%?  Ever wonder why it is more common than what we expect to see 15 consecutive "big" or "small" in Genting or any Casino?  That is why doubling down after losses will never work in the long run.  Money management will not help if your edge or average trade is negative!