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Stock Market Trading Analysis

by Carmelo J. Montalbano
  • Overview

    Stock Market Trading Analysis
    Stock Market Trading Analysis
    Entering a trade really begins with mapping a trading strategy. Prior to trading, the entire trading system should be written, tested and evaluated. The evaluation process has evolved greatly over the last several years as new mathematical concepts have proven very useful. Only after a system has been thoroughly evaluated under bull, bear and neutral conditions can it be said to be ready for real trading.
  • Measure Returns First

    Trading analysis begins with determining the profit and loss in a trade. From this information the trader can compute the number of winning trades and losing trades as a percentage of all trades. Next the trader should measure for every trade the maximum amount of gain that was possible. This is also called the maximum favorable excursion. The same practice should be done for losses and a maximum adverse excursion calculated. This allows the trader to determine whether the exit strategy could be improved so that the maximum profit or minimum loss be more efficiently constructed.
  • Measure Risk by Measuring Drawdown

    Traders regularly use several easy-to-calculate measures of risk. The first is to calculate the three greatest maximum draw downs or the highest to lowest value of a portfolio over the specified period. This is an important measure of the stability of the trading plan. Draw downs of over 20 percent should be eliminated by a change in trading plans, reducing risk per trade or just holding fewer positions.
  • Measure Trading Patterns by the Gain-Loss Ratio

    Traders can also measure risk per trade by dividing the ultimate profit of a trade by the amount of any temporary loss. Low numbers indicate that the trader is using too short a time frame for holding their investment or that too much risk per trade is being employed.
  • The Risk of Ruin Calculation

    Traders should examine the greatest consecutive number of gains and consecutive losses in order to measure risk of ruin. Begin by looking at the average loss per trade. Use that loss figure to compute how many consecutive losses of that size the trader could absorb before closing the account or bankrupting the account. Most traders find that 10 or more consecutive losses have decimated the account. The prescription is to lower the risk per trade and make certain the portfolio is diversified across many sectors.
  • Test Your Failure Rate by Loss Analysis

    Learn whether a trader needs to improve their entry strategy. Compose a list of all trades that never showed a profit and were ended by the sale of the stock (usually 8 percent of the amount invested). Examine how much further the stock declined before it turned and showed a profit. If 50 percent of your stock losses can be eliminated with a limit loss of 12 percent or less, consider risking less per trade but use larger stop or limit losses. The result should be an improved risk-reward ratio.

    References & Resources