There is only one reliable way to measure the level of success of a Forex trader and that is percentage growth on capital over a certain period. Metrics like number of pips, win rate, etc. are not useful to measure the success or profitability of a trader.
The more the % growth on capital the trader achieves in a specific time the more successful and profitable the trader can considered to be.
To achieve this the trader must have a reliable - and proven to be profitable -strategy or system that he/she is trading accurately and to the letter.
There are other factors to consider that also that determines the quality and profitability of a trader over a long period of time. The first one is that of consistency. Anyone can have a good or lucky month and make a big profit in one month but fewer traders can consistently make a profit every month over a long period of time. Therefore, we recommend that when trying to determine the success of a trader, strategy or system the periods over which the measurement(s) are done should be at least 3 months - but preferably much longer.
(To get a measurement of profitability in our formula discussed later in this article we will divide the number of months into the total % growth for the period to get the average % monthly capital growth)
Very closely related to consistency is trading with a low % standard deviation. If this metric is high, it means the trader is all over the place making random large and smaller profits and similar kinds of losses. There could be large differences in performance from month to month. One of the reasons could be that either the trader does not have a detailed set of rules for opening and exiting trades or otherwise he/she is not following the trading rules accurately and consistently. This makes the stability and on-going profitability of the trader uncertain.
But there is another very important factor that must be taken into consideration to get a more accurate understanding of the success or profitability of a trader - and that is RISK.
It is no good that a trader has a high return on capital, but he is trading at a very high risk that can destroy his capital over a short period. So e.g. if a trader has a return of 30% on capital per month but he/she is trading with a 60% maximum drawdown on equity (equity = balance +- open trades), or maybe even more, it means the trader has a high probability that sooner or later he/she may go into a large drawdown that will destroy the account – and in that way erase most/all previously made profits and making a recovery from a much smaller account a long and slow process.
It is important that the reader notice that we speak of drawdown on equity and NOT balance. Since measuring drawdown on the balance of the account will hide those dangerous situations where the account may have been close to or in the area of a margin call and then recovered before the trade(s) was/were closed.
(Unfortunately, the detailed statement of Metatrader 4 that is based on account history gives us the drawdown based on the balance, so we have no option but to use that figure. Metatrader 5 does give the drawdown based on equity in addition to the drawdown based on balance.
The trader should also be careful that withdrawals from and deposits to the account do not interfere with the drawdown calculations.)
So then, a better measurement for a successful trader would be as follows:
% Success Potential = % growth in capital per month / % maximum drawdown in the period measured * % standard deviation * 100.
So, if the capital growth over 6 months was 60% the average monthly growth will be 10%. If the maximum drawdown over that period of 6 months was 25%, and the % standard deviation is 2% we will calculate as follows:
Success Formula = 10/(25*2) *100 = 20.
Obviously the higher this number is the better trader, strategy or system we have, so if that number exceeds 20, we know that we have an excellent strategy, system and/or trader that can produce good profits at acceptable or low risk.
To create some guidelines for traders that they can implement to achieve such high success potential we have to take a much closer look at the two factors we just identified that measure the success of a trader, i.e.
% growth on capital
% growth on capital
This metric is made up from some underlying variables of which the most important are:
Risk: Reward or Average Profit vs Average Loss
Trading Frequency (Number of trades in certain period)
Money Management (average % risk on capital taken on every trade or on all open trades)
The Win/Loss % and the Risk: Reward is interlinked and should always be considered together. The lower the win rate the higher the risk: reward should be. E.g. a win rate of 60% should have a Risk: reward of at least 1: 1 for giving the trader a winning strategy.
Point number one: Make sure you have a winning strategy by ensuring you trade at a profitable win rate/risk: reward combination
Point number two: The more trades you have per month based on the above strategy the more profitable you will be.
Point number three: The higher the lot size the more profit will be made in currency terms (e.g. USD) for the same Take Profit size. This could be a sword cutting both ways and also cause a bigger loss, so the lot size will have to take into account your money management and drawdown restrictions.
The level of consistency can be measured in two ways.
% of losing weeks or months in e.g. a year
% Standard Deviation
We are looking for a consistently profitable weekly or monthly record equal or higher than 85%. So e.g., there should be a maximum of 2 losing months in a year.
In % standard deviation we are looking for an even record of wins and losses of similar size so that the % standard deviation should be a low percentage.
% Maximum drawdown
This metric is determined by factors like:
Number of losses in a sequence (losing streak)
Size of Stop Loss
These three factors work in combination and have an overall effect on the size of the % maximum drawdown. In a sense they are more important than the factors determining the profit since the focus in Forex trading should be on controlling and minimizing risk.
If the trader wants to be profitable, he/she should monitor these factors mentioned above that influence both the % capital growth and & % maximum drawdown on a regular basis. If they are out of bounds an attempt should be made to improve and optimize them to the most beneficial level in order to maximise profit.