Measuring Strategy Performance

I am frequently queried about the best way to determine how good a strategy is. TradeStation provides a lot of metrics on their “Strategy Performance Report” but most of them do a lousy job of measuring “goodness”. If I had to define “strategy goodness”, it would include a list of properties as follows:

o High net profit
o Lots of trades
o No outlier big win trade
o High percent of profitable trades
o Small drawdowns
o Short drawdowns
o Staying in market as little as possible
o Smooth equity curve

The problem with most of the metrics provided by the TS “Strategy Performance Report” is that they measure the goodness of only one of the properties listed above. This can distort your perception of the performance. The most common mistake is looking at “net profit” which is the standard metric used to rank performance in the “Optimization Report”. However, a high net profit often comes at the price of having one big outlier winning trade. You can spot this problem most easily be looking at the equity curve.

When running optimizer, it is often quite common to find users that ignore slippage and commission. This has the effect of pushing the optimizer to list results that take high numbers of trades with small profits; so small that it would be impossible to cover the cost of slippage and commissions. Yet the optimizer often picks settings that rank first the results with a miniscule average trade metric.
You can change the default metric used to rank optimizations by clicking on the TS menu “VIEW/CHART PREFERENCES” and select the “Strategy” tab. Then modify the “Fitness Function” selection to by “ALL: Avg Trade” which will at least guarantee that you view the list in an order that covers slippage and commission (assuming you have it set properly to begin with).

Then look down the list on the performance report and you will see the RINA index. It is not bad at identifying the “goodness”, however, it does fall short in measuring the impact of having one big winning trade. If you want the best measure of all, you need the PRRR statistic. This is the Pessimistic Return to Risk Ratio. You can find more about the PRRR on the home page of this site and you can even download the code as well. There you will also find a link to an article about the PRRR published on “Trader Planet” that explains its use.