In the previous post I talked about the different variables in play to determine a good risk management model and technique. One of the variables was the trader’s edge. How do you know you have a real edge? How do you know how good that edge is?
To objectively know if your system is truly working you need to put in place some metrics and analyze your performance regularly. Start by looking at how large your winners vs. losers are. The largest winners should ideally be 3x your largest loser. Also look at the number of winning trades vs. losing trades and make sure you have a good “bating” average. Using the baseball analogy, you want to have a large number of hits with a few home runs and very few strike outs.
This year I began to post an analysis summary of my monthly performance on the blog. Take a look (Jan and Feb.) to see some of the metrics that I use and the conclusions reached after the analysis. It is important that you use the analysis results to develop steps to correct mistakes and to reinforce what you are doing well. This is a necessary process to develop a real edge and manage your risk effectively.