optimism and quantify each trades profit objectively. The best way to measure this performance is with a calculation called run-up. Essentially run-up is the opposite of drawdown. If drawdown looks for trading low points, then run-up centers on the high points.

Run-up can be calculated in several ways: largest gain, maximum favorable excursion, average run-up, largest consecutive winning series, or maximum equity gain. Each definition represents a different form of reward (see Box 7).

The largest gain is the trade that makes the most money during the trading period. Does this trade justify trading the system? That depends on whether the system was designed to rely on outliers. In general, the largest gain should not exceed 20 percent of net profit.

Another measure of run-up is maximum favorable excursion (MFE).4This form of run-up is the reverse of maximum adverse excursion (MAE) as mentioned in the previous section. MFE can be calculated in two formats. The first represents the single largest unrealized gain experienced by a system. The second MFE calculation averages each individual trades largest unrealized gain. These calculations combined with the largest gain paint a general picture of reward for the system.

Figure 9.8 plots each trades individual MFE. The high of each bar represents the trades largest unrealized gain during the trade. The low of each bar represents the trades realized profit or loss. The reader may want to verify that unrealized gain is never less than realized profit or loss. Using Figure 9.8 as a reference, the systems largest gain and MFE occurred, coincidentally, on trade number 93.

A systems largest consecutive winning series and maximum equity run-up round out our discussion of run-up. They are easy to calculate. The largest consecutive winning series for the system reviewed in Figure 9.7 gained a total of $43,999. The largest single gain for the same system was $39,519 (see Table 9-9).

Since a system can have many run-ups and drawdowns, it is possible to evaluate the standard deviation of each as well as the coefficient of variation (CoV). The CoV

Box 7

RUN-UP

Largest gain: The largest profitable trade for the test period.

Maximum favorable excursion (MFE): The largest gain based on the ultimate high for long positions or low for short positions during the trade.

Average run-up: The average MFE figure for each individual trade.

Largest consecutive winning series: The largest consecutive winning series for the test period.

Maximum equity run-up: The largest equity increase during the test period, as measured from the lowest running equity value to the highest.

Figure 9.8 profit and loss run-up.

P&L / Run-up RTNA1 qNSP 460000-Daily (08 9/85-08/01/97)

1 11 21 31 41 51 61 71 81 91 Trade Number

for run-ups and drawdowns should be 150 percent or less. Values greater then this have a tendency to generate inconsistent results when used with money management techniques.

Reward/Risk Ratios

Reward/risk ratios center on a systems profitability in relation to risk. Theoretically, the larger the ratio the better the system.

The previous section on drawdown and run-up sets the stage for a few simple yet powerful ratios. Countless ratios can be created, but in this discussion we will center on only three (see Box 8). Each formula attempts to critique performance on a risk-adjusted basis. They are simple to calculate and extremely informative. All too

Table 9.9 Run-up analysis

BOX 8

REWARD/RISK RATIOS

Largest loss ratio: Largest loss divided by net profit. Look for a ratio of 0.1 or less.

Max drawdown ratio: Maximum adverse excursion (MAE) divided by net profit. Look for a ratio of 0.1 or less.

Average run-up/drawdown ratio: Average run-up divided by average drawdown. Look for a ratio of 1.5 or more.

often, individual traders center on risk or reward calculation never bothering to combine the two into a simple ratio.

Two trading systems are shown in Table 9.10. Although System A made $ 100,000 more than System B, the additional profit does not justify the risks associated with its trading. Based solely on these simple ratios, System is the better of the two systems because its profitability was much more risk averse. Reward/risk ratios point out that sometimes less profitable systems can be more desirable.

Consecutive Trades

Short-term trading confidence, or a lack thereof, often stems from the number of consecutive winning and losing trades produced by a system. After a winning streak, you can become overly confident and believe that your system is infallible. Conversely, after a few losing trades, you may become easily discouraged, risk averse, and perhaps even reluctant to trade. In either case, the trading principles behind your system have remained constant, while your perception of the system has changed. By tracking the performance of consecutive trades, you can gain additional insight into the personality of your system and thereby trade with greater confidence.

This discussion of consecutive trade analysis begins with a definition. A streak is defined in this chapter as a sequence of only winning or only losing trades that occur