Improvement of trading performance in forex binary options is a continuous exercise in commitment. Perhaps you have been in the market for some years, or you have followed this blog for quite some time. The question is: have your trading skills improved, or have you remained static? This article will present some key performance parameters that can help you evaluate your trading performance.
Key Performance Metrics
Self-evaluation of forex trading skill will involve many variables. Some of these performance metrics will come in handy when evaluating your forex trading skills:
a) Win/Loss Ratio
At the end of the day, the win/loss ratio is a key metric in assessing performance, though this is not always a reliable index of success. A win/loss ratio comes to play if the trader’s risk-reward ratio is 1:1, in which case the number of pips sought as profit is equivalent to the number of pips risked. It also comes to play when the trader sticks to acceptable risk exposure levels for all trades. Win/loss ratio will not be valuable for traders who cut their profits and let losses run, in which case even a low level of loss will be enough to obliterate any profits made from far greater number of trades. It will also not be valuable in assessing trades where the risk-reward ratio is 1:2 and above, in which case a careful trader can lose more trades than are won and still come out on top.
So the trader needs to first come up with a personalized profitability curve that will describe the trader’s trading style (from the several scenarios painted above), and then an average profit/loss ratio curve can be plotted to determine if the trader is profitable and secondly, if there is a measure of stability in maintaining profitability. Ask yourself after conducting a series of trades (10 or more): What does my profitability curve look like?
b) Adjusted Win/Loss Ratio
To take care of some of the imperfections of the Win/Loss ratio, we tweak this metric a little to come up with what we call the Adjusted Win/Loss Ratio. How would your performance look like if you took out the best-winning and the worst-losing trade from the calculation? This would give you the adjusted average gain/average loss, or adjusted win/loss ratio. It produces a more realistic performance result than the original win/loss ratio, because the skewing effects of one huge gain or one huge loss have been eliminated from the calculation. The adjusted win/loss ratio is therefore a better indication of the actual core skill level.
c) Distance from Break Even
The trader must first hit breakeven point beyond which profitability is achieved. Breaking even in your forex trades is therefore a very significant milestone. It means that the trader is almost at the Promised Land, and perhaps with a few tweaks, profitability will be achieved. Evaluation of performance and the risk of loss can be achieved by determining how many trades will take a trader’s account to break even
Another way to look at this is to understand that the path to profits must first cross the break-even barrier. For each combination of these three there is a number of winning trades it takes to reach a break-even point. In other words, any number less means that the trader is not profitable. For example, if a trader only makes $30 for every $100 invested into a mini-lot forex trade and sets a 100 pip stop loss, it will take at least 4 winners to offset just one trade loss!
In other words, the more profits made in a trade, the lesser number of trades required to hit breakeven point. This is why traders are always advised to seek trade opportunities that have far greater rewards than risk.
d) Win/Loss Duration
Over time a personalized pattern and style of trading will develop from one trader to another, and traders will be able to determine what they did to get a winning trade and what they did to bungle a trade. These can provide important clues on how to trading performances can be improved. One such behavioural pattern that can be identified as being key to profitability or loss is the duration of trades. Are profits made from trades that were taken intraday or left open for a few days? On the average, how long did a winning trade last? How long were you in a trade that ended badly? Did you lose pips by being in a trade too long? Did you cut profits too early? Did you hang on too long to a hopelessly bad trade?
A lot about the trade duration profile will reflect the trader’s psychology. Set-and-forget traders tend to be the more assured types of traders, while the frantic guys tend to keep an eye on the charts all day long and tend to run off with lesser profits than they should be taking home.
e) Trading Sequence Patterns
There will be times when a trader experiences wins and losses in a streak fashion. However, the pattern of winning and losing streaks tells a lot about the quality of the trader’s skill. There is always a tendency to complacency when the trader is on the end of a winning streak. Winning streaks occur as a result of bring correct in trade calls and knowing how to apply the psyche to trades. Traders may get overconfident, and unnecessarily daring at the tail end of a winning streak, and they begin to make a lot of mistakes. This is where a careful psychological approach comes in to weed out the negative emotions like overconfidence and greed.
In the same vein, a losing streak dampens the morale of a trader and they end up getting desperate and judgmental in their approach to the next trade. Therefore, the pattern of winning and losing streaks is something that also requires evaluation. What is responsible for a winning streak and how can such a streak be maintained? What is responsible for a losing streak and what must be done to snap such a streak?
The next step in performance evaluation is to assess your results on a forward-looking, real-time basis. This means planning and putting on trades with a strategy in mind. The probability of improving performance is related to your skills and not the market. Each performance challenge tests a core forex trading skill.
No one single strategy applies to all traders. Each trader applies their own personality to the trading and only after many trades can a real trading plan emerge. That is why in the next paragraph, we have designed a series of trade challenges that will help a trader evaluate how they would approach different scenarios in the marketplace. A trader can do one challenge over one week or take more time. This challenge will require a good amount in trading capital so that trades can be placed at a frequency which gives the trader sufficient exposure to changing market conditions. The challenge is presented below:
This trading challenge is designed to assess the trader’s response with trading skill and psychology, to the varying market conditions in the forex market. Ten trades are to be taken for each condition to eliminate any results that can be termed a fluke.
- Take 10 trades to see how good you are at timing trade entries. This is essentially trading with the trend. Locate a currency pair which is trending and see whether you can enter the trend early and make a good number of pips.
- Take 10 trades to assess your ability to join the crowd after confirming a strong trend direction. This is to assess your ability to trade on the retracement. You will therefore use the Fibonacci retracement tool for this challenge.
- Take 10 contrarian trades to see how good you are at evaluating reversals. Your challenge is to enter against the existing trend, and see how many times you get this right.
- Take 10 Gut trades. See how good you are at making instinctive judgments about market direction. See if you are the type that over-analyzes markets to the point of inaction, or you are the type that does not believe in market analyses before making a trade.
- Take 10 range trades. This will involve trading off sideways channels, or other avenues of detecting ranging markets where you will have to buy on support or sell on resistance.
- Take 10 Breakout Trades using chart patterns, price channels or any other method of technical analysis which will end with a breakout trade.
- Trade 10 News Release Trades: Specifically locate the economic calendar for an important news release and trade this release using any strategy you have seen discussed on this blog.
- The Grand Challenge: Take 30 Mixed-Strategy Trades: After you have done the first 7 strategy tests, look at the results and pick out the best three strategies you have going and put on 30 trades on them; i.e. 10 trades per strategy.
These performance challenges are designed to provide milestones for evolving as a forex trader. The results of each performance challenge will provide important data to assess your strengths and weaknesses. After this challenge, if you have been the trader that trades anything with any strategy, you will have discovered where you are weak and where your strength lies, in order to use it to streamline your trading activity.
While placing of trades is ultimately the best form of testing your skills, it’s important to also challenge your ability to analyze the forex market. The following challenges that test the ability of the trader to perform technical analysis do not get obsolete and can be done anytime.
- Scan the forex pairs for currency pairs which just reached new weekly highs. What is the reason for the new highs?
- Among the floating currency pairs, which two pairs have the widest interest-rate differentials?
- What is your adjusted win/loss ratio (remove the highest gain and the highest loss, and then re-compute the result)?
- Scan the four-hour charts of the underlying markets and select one that has a compressed triangle forming. Put on a breakout trade around that triangle.
- Find the forex pairs that hit new weekly lows. What is the reason for the new lows?
- Look at the high impact news releases for the Chinese Yuan, and trade the AUDUSD based on the outcomes. What are the results?
- Find two forex pairs that have had a very narrow sideways channel in the past month. Place a breakout trade on each market.
- Trade the rest of the high-impact data for the AUDUSD and document the results. How does the AUDUSD typically respond to these news releases in terms of the spike and subsequent price movement?
- Locate and review the non-farm payroll jobless claims data and determine if there is a trend up or down in the data.
- Determine on the economic calendar when the next Tankan report is coming out.
- Which of the forex pairs are experiencing a sideways channel on the daily chart?
Trading performance can be viewed on a trade-by-trade basis, but it can also be viewed from total-return perspective. This later approach is more a top-down approach and, in fact, makes a huge difference on how each trade is viewed. The bottom-up approach looks at each trade as its own self-contained opportunity. In contrast, the top-down approach views each trade as a component towards a total return per week or per month. Each trade is, metaphorically, a component in a trading factory. The question arises: What’s the production of the factory for each week or month—in terms of total return.
There are different ways to approach binary option trading from a total return perspective, and all are legitimate because they reflect the fact that traders have varying goals. Some traders seek the opportunity to put on a position for a very high return. These traders are high rollers, with large risk appetites. This kind of trader searches for binary contracts that offer the opportunity to payout a $100 on a risk of $20 (therefore delivering 5:1 returns in less than a week). In contrast, the other group of traders is looking for high probability returns. For them, binary option contracts costing $75 and higher often are attractive. They offer less rewards, but a higher probability of success.
Whether one trades for high returns or high probability, there are two distinctive total return perspectives. You can view binary options on a trade-by-trade basis and enjoy the experience. An analogy would be doing a round of golf, but not keeping score. Another approach is a total return portfolio approach. This means using binary options as mechanism for achieving a total-return goal.
The total-return approach, in effect, reverses the process of shaping the binary option trade. Instead of starting with a scan of the market, and identifying price patterns and opportunities, the trader starts by setting total return portfolio goals. This approach is a manufacturing model. It views traders as managers of a manufacturing process that produces profi ts per year, month,
and week. Here are three questions that help you shape a binary option portfolio return plan. Ultimately, all total-return strategies can become translated into how you answer these questions.
- What is your total return goal for a year?
- What is your total return goal for a month?
- What is your total return goal for a week?
For example, a 50-percent total return for one year of trading is a result that is not only admirable, but that places one among the better traders in the world. This results in a 4.1 percent return per month, or just over 1 percent a week. Having shaped a performance goal for the week, the next step is to develop a set of binary option trading strategies that contribute to that objective.
Here is an example, in Table 10.2, of one week’s trades that resulted in a 1 percent return for the week. The 1-percent-per-week results would be competitive with any world-class manager, but by using the binary option trading tools they are within the reach of ordinary persons. The example represents a sample set of trades, but it is still instructive. What can we learn from it? First, that binary option trading strategies are not a single pure strategy. The trades represent a combination of deep in-the-money trades, at-the-money, and breakout trades. Of course, there are many combinations possible. Only after conducting a large number of trades per strategy can the best personal mixed strategy for any trader be developed.
Let’s look at a possible combination set of trades or recipe that would result in a 1 percent return for the week (Figure 10.2). In reality, there are many ways to accomplish this, but it is suggestive of what it takes. The inputs are trades, and the trades result in a total cost. The output, if profitable, should be enough winners with big enough size wins to result in a net profit. In a real sense this is a recipe for a 1 percent weekly total return for a $10,000 account.
Using Your Personality Type Positively
The habits of traders enable us to classify them according to different personality types. Trading is an emotional activity, as money is involved and money sums up all our efforts on a day to day basis. Recognizing one’s personality as a means towards being able to use it positively in the market is one way that traders can limit their risks. Understanding your personality will help you use the right trading strategy that matches that personality.
So what are the different personality types that we see among traders in the market?
The Hunch Traders: This personality type is that which acts on emotions than on common sense. Traders who trade on-a-hunch like to rely on gut feeling to enter or exit a trade. While this may work once in a while, it will invariably lead to more losses than profits. This is a bad personality type. There is no room for guesswork as far as the forex market is concerned.
The Sniper: Snipers like to conduct thorough analysis on the market and will only take trades when their pre-set conditions have been fulfilled. Some of the strategies we have outlined in this blog are suited to sniper traders. This approach requires patience; something that is seriously lacking among retail traders. For instance, snipers will prefer to wait for the price action that they feel will reverse to first test the reversal point, or use limit orders to perform such trades, than jumping straight into the market with a market order. Breakout traders who wait for some form of pullback before making entries are sniper traders. This is a good personality type for trading, and helps traders who adopt this style to cut down mistakes to the barest minimum.
The Herder: This type of trader reacts to market moves by running with the crowd. Recall how lambs tend to cross the road in a herd right after their leader, even with danger coming? This is just how lamb traders react. When a lot of such traders come into the market they add energy to the momentum of the prices, but not in their favour. Usually, this helps snipers to add more profit to their already profitable positions, and then as momentum surges to the maximum, the snipers get out and dump their positions on more herd traders, with bad results for this trader personality. These are the guys whom Warren Buffett warned about when he talked about getting fearful when others (the herders) get greedy.
The Contrarian: Going against the crowd takes guts. There were traders who bet against the housing markets in the US and after enduring months of their positions being in the red, they hit it big when the housing market eventually collapsed. A particular hedge fund trader raked in 600% gains when this happened. To be a contrarian trader, you have to have a solid basis for such a contrarian position.
It takes courage to be a contrarian. But when the contrarian is right, profits can be very large.
The Gambler: The gambler is one who combines the personality of the hunch trader with an adventurer. Gamblers do not mind adding more money to their account to continue trading even when they are not making good results. This is not a good way to trade forex.
By examining your own trading habits, you can almost slot yourself into one of the forex trader personality types. It is now left for you to either make adjustments where you need to, or to jettison a negative personality for a positive one.
The author’s views are entirely his or her own.