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Whether looking at hypothetical results or actual trading data, there are hundreds of performance metrics that can be applied. These performance metrics are typically displayed in a strategy performance report, a compilation of data based on different mathematical aspects of a system's performance. Knowing what to look for in a strategy performance report can help traders analyze a system's strengths and weaknesses.
A strategy performance report is an objective evaluation of a trading system's performance. Traders can create strategy performance reports to analyze their actual trading results. A set of trading rules can also be applied to historical data to determine how the system would have performed during the specified period—a process called backtesting. Most market analysis platforms allow traders to create a strategy performance report during backtesting, a valuable tool for traders wishing to test a trading system before putting it to use in the market.
The "front page" of a strategy performance report is the performance summary. Figure 1 shows an example of a performance summary that includes a variety of performance metrics. The metrics are listed on the left side of the report; the corresponding calculations are found on the right side, separated into columns. The five key metrics of the report are underlined; we'll discuss them in detail later. Figure 1 - The "front page" of a strategy performance report is the performance summary.
The key metrics identified in this article appear underlined. In addition to the performance summary seen in Figure 1, strategy performance reports may also include trade lists, periodical returns, and performance graphs. The trade list provides an account of each trade that was taken, including information such as the type of trade long or short , the date and time, price, net profit, cumulative profit, and percent profit.
The trade list allows traders to see exactly what happened during each trade. Viewing the periodical returns for a system allows traders to see performance broken down into daily, weekly, monthly, or annual segments. This section is helpful in determining profits or losses for a specific time period.
Traders can quickly assess how a system is performing on a daily, weekly, monthly, or annual basis. It is important to remember that in trading, it is the cumulative profits or losses that matter. Looking at one trading day or one trading week is not as significant as looking at the monthly and yearly data. One of the quickest methods of analyzing strategy performance is the performance graph. This shows the trade data in a variety of ways, from a bar graph showing a monthly net profit to an equity curve.
Either way, the performance graph provides a visual representation of all the trades in the period, allowing traders to quickly ascertain whether or not a system is performing up to standards. Figure 2 shows two performance graphs: one as a bar chart of monthly net profit; the other as an equity curve.
Figure 2 - Each performance graphs represents the same trade data shown in different formats. A strategy performance report may contain a tremendous amount of information regarding a trading system's performance. While all of the statistics are important, it's helpful to narrow the initial scope to five key performance metrics:. These five metrics provide a good starting point for testing a potential trading system or evaluating a live trading system. The total net profit represents the bottom line for a trading system over a specified period of time.
This metric is calculated by subtracting the gross loss of all losing trades including commissions from the gross profit of all winning trades. The formula would be:. So, in Figure 1, the total net profit is calculated as:. While many traders use total net profit as the primary means to measure trading performance, the metric alone can be deceptive. By itself, this metric cannot determine if a trading system is performing efficiently, nor can it normalize the results of a trading system based on the amount of risk that is sustained.
While certainly a valuable metric, total net profit should be viewed in concert with other performance metrics. The profit factor is defined as the gross profit divided by the gross loss including commissions for the entire trading period. This performance metric relates the amount of profit per unit of risk, with values greater than one indicating a profitable system.
As an example, the strategy performance report shown in Figure 1 indicates the tested trading system has a profit factor of 1. This is calculated by dividing the gross profit by the gross loss:. This is a reasonable profit factor and signifies that this particular system produces a profit. We all know that not every trade will be a winner and that we will have to sustain losses. The profit factor metric helps traders analyze the degree to which wins are greater than losses.
The above equation shows the same gross profit as the first equation but substitutes a hypothetical value for the gross loss. In this case, the gross loss is greater than the gross profit, resulting in a profit factor that is less than one.
This would be a losing system. The percent profitable metric is also known as the probability of winning. This metric is calculated by dividing the number of winning trades by the total number of trades for a specified period. As an equation:. In the example shown in Figure 1, the percent profitable would be:. The ideal value for the percent profitable metric will vary depending on the trader's style.
Traders who typically go for larger moves, with greater profits, only require a low percent profitable value to maintain a winning system, because the trades that do win—that are profitable, that is—are usually quite large. This typically happens with the strategy known as trend trading.
The trades that do not win are usually closed for a small loss. Intraday traders, and particularly scalpers , who look to gain a small amount on any one trade while risking a similar amount will require a higher percent profitable metric to create a winning system.
This is due to the fact that the winning trades tend to be close in value to the losing trades; in order to "get ahead" there needs to be a significantly higher percent profitable. In other words, more trades need to be winners, since each win is relatively small. The average trade net profit is the expectancy of the system: It represents the average amount of money that was won or lost per trade. The average trade net profit is calculated by dividing the total net profit by the total number of trades.
In our example from Figure 1, the average trade net profit would be:. Profit margin is a percentage measurement of profit that expresses the amount a company earns per dollar of sales. If a company makes more money per sale, it has a higher profit margin. Gross profit margin and net profit margin , on the other hand, are two separate profitability ratios used to assess a company's financial stability and overall health.
While gross profit and gross margin are two measurements of profitability, net profit margin, which includes a company's total expenses, is a far more definitive profitability metric, and the one most closely scrutinized by analysts and investors. Here's a more in-depth look at gross profit margin and net profit margin. Gross profit margin is a measure of profitability that shows the percentage of revenue that exceeds the cost of goods sold COGS.
The gross profit margin reflects how successful a company's executive management team is in generating revenue, considering the costs involved in producing their products and services. In short, the higher the number, the more efficient management is in generating profit for every dollar of cost involved. The gross profit margin is calculated by taking total revenue minus the COGS and dividing the difference by total revenue.
The gross margin result is typically multiplied by to show the figure as a percentage. The COGS is the amount it costs a company to produce the goods or services that it sells. Using the formula above, it would be calculated as follows:. This means that for every dollar Apple generated in sales, the company generated 38 cents in gross profit before other business expenses were paid. A higher ratio is usually preferred, as this would indicate that the company is selling inventory for a higher profit.
Gross profit margin provides a general indication of a company's profitability, but it is not a precise measurement. It is important to note the difference between gross profit margin and gross profit. Gross profit margin is shown as a percentage while gross profit is an absolute dollar amount. The gross profit is the absolute dollar amount of revenue that a company generates beyond its direct production costs. Thus, an alternate rendering of the gross margin equation becomes gross profit divided by total revenues.
The gross profit figure is of little analytical value because it is a number in isolation rather than a figure calculated in relation to both costs and revenue. Therefore, the gross profit margin or gross margin is more significant for market analysts and investors. The net profit margin is the ratio of net profits to revenues for a company or business segment.
Expressed as a percentage, the net profit margin shows how much of each dollar collected by a company as revenue translates to profit. Net profitability is an important distinction since increases in revenue do not necessarily translate into increased profitability. Net profit is the gross profit revenue minus COGS minus operating expenses and all other expenses, such as taxes and interest paid on debt. Although it may appear more complicated, net profit is calculated for us and provided on the income statement as net income.
Using the formula above, we can calculate it as:. A higher profit margin is always desirable since it means the company generates more profits from its sales. However, profit margins can vary by industry. Growth companies might have a higher profit margin than retail companies, but retailers make up for their lower profit margins with higher sales volumes.
It is possible for a company to have a negative net profit margin. A negative net profit margin occurs when a company has a loss for the quarter or year. That loss, however, may just be a temporary issue for the company. Reasons for losses could be increases in the cost of labor and raw materials, recessionary periods , and the introduction of disruptive technological tools that could affect the company's bottom line.
On the other hand, a low or negative GPR is a warning signal as it indicates a weak operating performance of a company. The formula for GPR can be derived by deducting the cost of goods sold from the total revenue and then dividing the result by the total revenue. The ratio is usually expressed in terms of percentage. Mathematically, it is represented as,. The total revenue is the product of the average selling price per unit and the number of units sold, while the cost of goods sold primarily consists of the cost of raw material and direct labor cost.
Both of them are important financial metrics and as such, they are easily available in the income statement of any company. Calculate the gross profit ratio of GHJ Ltd during the year based on the given information. Let us now take the annual report of Apple Inc. Calculate the gross profit ratio for Apple Inc. Source: d18rn0p25nwr6d. Let us now take the annual report of Walmart Inc. Calculate the gross profit ratio for Walmart Inc.
Source: s2. So, the gross profit ratio can be a useful profitability metric. It also shows that the company has more to cover for operating, financing, and other costs. The gross profit margin may be improved by increasing sales price or decreasing cost of sales. However, such measures may have negative effects such as decrease in sales volume due to increased prices, or lower product quality as a result of cutting costs.
More under Financial Statement Analysis. Financial Ratios. Gross profit margin. Gross profit margin Net Profit Margin. Liquidity Ratios. Financial Statement Analysis.