Today's Quote: “You only win if you aren't afraid to lose." Rocky Aoki.

There is a statistic that every trader should be tracking as part of their daily ritual. By the end of the week it will tell you a lot about your trading and will also go a long way to monitor if you are making improvements or not. We like to refer to it as a "simplified Sharpe ratio", which is also known as just "Win/Loss Ratio". The actual Sharpe ratio is a discovery by a man of the same name and is used in many business and mathematical areas. We use a very simplified form of this that compares your average winner to your average loser, but it is very important.

One of our goals as traders regardless of what time frame we are playing is to find chart patterns that have a relatively large target compared to the stop. The biggest problem for most traders is that the reward to risk ratio (RR) number becomes a fallacy. This happens because many traders never realize the RR that they project. In other words, what good is a 3-1 RR if you always sell way before you hit the ‘3’? What we need is a way to track how much of that RR you are ACTUALLY capturing. It is one thing to project a big RR. It is entirely another to bring it home to the bottom line.

The Sharpe (Win/Loss) ratio formula is the average dollar earned over the average dollar lost:

total winning trade dollars / number of winning trades
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 total losing trade dollars / number of losing trades

If every winning trade you have makes 100 dollars and every losing trade loses 100 dollars, you would have a Sharpe of 1.0. If there is one formula you should apply to your trading stats, this is the one. Once traders get past the evils of not taking stops, they often begin to find some success. They start to have some winning days and start to feel good about what they know, and feel they are making money consistently. The only problem is that their account is not growing. For these people it is very likely that a look at their Sharpe ratio would reveal a very low number and thus, the evils of their trading.

So your first question is, ‘What is a good Sharpe ratio?’ Well the answer could be a couple chapters in a book, but we will look at that a little tomorrow.