Thanks to reader Theo who emailed me to point out that it was high time I finish this series.  Sorry for the delay!

Please read parts one and two of this series here.  Everything I wrote there is important for this process, and I will not repeat that info in this post for the sake of brevity.

So you have done everything in the previous posts, you have a good consistent set of records that cover all your trades with nothing left out, and you’re ready to do some quantitative analysis on your results.  Before we jump into this, it is important to consider what this analysis can and cannot show you.  First of all, at the end of this process you are going to know, with a fair degree of certainty, if you actually have an edge in trading or not.  One of the advantages of doing this kind of analysis is that the numbers will not lie.  There is no place to hide, and many traders will be shocked when they first look at their numbers like this.

It is also worth considering that, especially for developing traders, this type of analysis is an important part of your self-evaluation, but it is not enough.  You need to be keeping a journal that helps you focus on the psychological and performance issues related to trading… to get past the actual numbers to the core reasons why you are or are not performing as a trader.  For the beginning trader, don’t make the mistake of thinking you can crunch some numbers and get a complete view of your development as a trader.  The numbers are the bottom line, but realize that they are the result of your performance of your trading edge. Speaking personally, doing this kind of analysis keeps me from getting stupid — I know that if I do not execute my system faithfully then it is impossible for me to really quantify how good my edge in the market actually is, since my numbers will be a jumble of a valid edge and random elements from my performance issues.  I have found that doing disciplined analysis of my results forces me to be even more disciplined in my actual trading.  (This, by the way, is kind of the definition of a “win-win” situation!)

I would suggest carrying this analysis out on two levels–trade by trade and day by day.  First of all, for daytraders the end of the day is an important break point, so it makes sense to evaluate each day’s performance, both on a gross and net (of all transactions costs) basis.  As anyone who has traded for more than a few days knows, it is also important to not get too emotionally attached to any one day, but to view your performance over a larger sample size of days as well.  Specifically, I calculate the following over the past 10 days:

• Average day (winning and losing)
• Median day (winning and losing) (if you don’t understand the need for a median in addition to a mean, don’t worry about it.  You will get a lot of information from the mean anyway.)
• Standard deviation (winning and losing)
• Repeat this for winning days as a separate group, and also repeat for losing days as a group.
• Percentage of days that are winning days
• Repeat this entire analysis for the past 50 trading days as well.

One of the interesting things we can do is to plot each day as a bar against the average and standard deviation of the past 50 trading days.  A constructive way to use this kind of analysis (or, actually, any statistical analysis) is not to give us answers as much as to tell us what questions to ask.  Asking the right questions is often half the battle.  Consider the following graphs from three different traders:

In this chart, each blue bar is a single trading day, above and below a clear zero line.  The thick blue line is the average of recent trading days, and the larger, light blue area is a +/- 2 standard deviation band around the average.  What can we see from this trader’s performance?  Well, it looks like something has changed because the standard deviation of his trading days has really widened to the right of the chart.  This might not be a bad thing (perhaps could be a result of increasing trading size for instance), but in this case there are a string of about 10 losing days that need to be explained.  There could be many reasons for this; all the statistical analysis in the world is not going to get us any closer to those reasons, but we at least know the right questions to ask.  It is interesting to see that this trader does seem to be able to put together some good winning days, but we need to find out what is driving the big streak of losing days.  If we see nothing else, we are concerned that this trader’s average day has dipped far below the zero line, so it is definitely time to have a conversation.

This trader also has some interesting issues.  There is no consistency or regularity in these trading days.  This trader seems to be able to put together some winning days, but a number of very large (-4 standard deviations???) losing days completely erase any edge he might have.  Predictably, his average is wandering back and forth on both sides of zero and it seems unlikely he will make money until he can get some more consistency to his days.  What is driving this inconsistency?  We can’t tell from this analysis, but that is an important question to ask.

Lastly, here is a trader who seems to be firing on all cylinders.  A large number of positive days, a rising daily average (looks like bad things might have been happening off the left edge of the chart), and, perhaps best of all, notice that his light blue band is contracting.  As those of you with formal Finance backgrounds know, this is about the best you can ask for — an increasing average return with a decreasing standard deviation.  This shows that this trader seems to have identified an edge and seems to be applying it with consistency.

These three examples give you some idea of what you can do with a fairly simply analysis of daily trading numbers.  If you are a longer-term trader, it might be more appropriate to do it on a weekly basis.  If you are a swing trader, it may also make sense to do this analysis on a trade by trade basis in addition to, or perhaps in place of day by day.  In other words, you can keep a graph of each trade either by entry date or exit date.  I don’t think there is right or wrong, but it is important that you are consistent.  Remember, the point of this analysis is to find the right questions to ask so you can understand what is driving your performance.   I had planned for this to be the last in this set of blogs, but I think it is best to save the trade by trade analysis for the next blog, which I will try to write very soon!