I asked my brilliant wife to help me work out some issues I was having with calculating information for the two screens I wrote about in the previous post. She insisted that I needed a measurement of risk for each trade. I insisted that I didn't. She was right.
So I went back and re-calculated the expectancy for each screen and edited the post with more accurate information. What I learned in trying to figure things out is that the expectancy of each screen will measure the average risk of a trading system. For example, the Zweig RS 5 screen's expectancy is .18. So, if you make 100 trades you should average about 18 times the risk that you took on each trade over those 100 trades. The system produced 244 trades over 2007, so if you risked 1% of your portfolio value on each trade you should expect about a 43.92% return over the year.
I went back and applied a 10% stop loss to all the losing trades to even out some of the larger losses that probably would have been avoided with a stop loss. I know that a few of the gainers would be stopped out as well, but I didn't take that into account. A 10% stop loss shoots the expectancy up to .79. Nice. That brings an expectation of a 193% yearly return risking 1% per trade on 244 trades.
Using expectancy and risk analysis allows you to make better decisions about your system and your stop losses, while allowing you a better way to compare systems. This is the first time since I started trading that I have analyzed things in this way and it has really helped me get a better handle on what I am doing. I think that I can get to the point where my emotions and feelings don't control my trading behavior. I no longer will need to labor over the placement of stops, or obsess over finding the "perfect" system.
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