Last Updated on June 24, 2020
What is considered a good track record in trading? Making 25% per year annualized with low correlation to the market for 3 years, with a 10% maximum drawdown, and being profitable 90% of the months (Up 33 months out of the last 36) is an example of a fantastic record.
Let’s break down a good record into 5 components.
What are the components of a good track record in trading?
The 5 components are:
- Duration
- Returns
- Correlation of returns to the overall market
- Risk
- Consistency
While there is no hard and fast rule of what is a good track record, here is a minimum criteria to guide you along:
- Duration: 2 years
- Returns: 15% annualised
- Correlation of returns to the overall market (Alpha vs Beta): Low or none
- Risk: Maximum drawdown = your annualised returns
- Consistency: 70% winning months
Duration
The longer your track record, the more statistically significant it is.
This means that your awesome performance is not a fluke or luck – that you didn’t happen to buy Bitcoin in early 2017 and sold in early 2018 because your friend told you so to.
It is even better if you traded through various market regimes.
For instance, you traded in the period before the Global Financial Crisis of 2008, during, and after the crisis, and managed to make money in all 3 periods.
This is a sign of a good trader who is able to adapt, or has a strategy that is fundamentally valid regardless of market behaviour.
Returns
The short answer is here that, you need to beat the S&P500 index over the long run.
Returns should be measured against opportunity cost.
If someone can make 8% by putting money in a S&P 500 stock ETF, they will expect more if they have to put in effort and take more risks.
S&P 500 returned 15% annualised for the last 10 years (it is 2019 at the time of this writing).
S&P 500 returned 3% annualised for the last 20 years.
The last 10 years have been good to US stock holders.
The number to beat is 15% not 3%.
Correlation of returns to the overall market (Alpha vs Beta)
Let’s start with explaining the meaning of overall market.
What is the overall market?
What this overall market is depends on what assets you are trading.
For instance, if you trading US stocks, the relevant overall market is the S&P500 index.
If you are trading commodity stocks, the overall market could be the MSCI World Commodity Producers Index.
If you are trading cryptocurrency, then the overall market is… Bitcoin?
Beta
If your returns are correlated to the overall market you are trading in, it indicates that your strategy generally involves buying and holding certain popular assets in your asset class.
In trading this is known as a Beta-related strategy. Beta is a term that refers to the sensitivity to the overall market.
Beta-related strategies goes up when the overall market goes up, and down when the overall market goes down.
Alpha
If your returns are lowly or not correlated to the overall market you are trading in, it indicates that you are doing something different (and special) from the other market participants.
You have some sort of magic pill and edge over the others!
In trading, this is known as having Alpha.
Alpha is a term that refers to risk-adjusted returns above the general market.
Is Beta or Alpha more desirable?
Generally, Alpha-based strategies are better due to stability of returns and potential of returns that greatly outperform the overall market.
However, Beta-based strategies are not necessarily a bad thing, especially if you outperform the overall market – win more than the overall market when it goes up, lose less than the overall market when it goes down.
Most investment firms and mutual funds are Beta-based.
But most traders want to have a successful Alpha-based strategy as it means you are making money consistently regardless of how the overall market perform.
Moreover, Alpha-based strategies have the potential to outperform the market vastly (high-frequency firms ahem).
If you are raising funds, investors will be more keen on Alpha-based strategies.
They are keen because, in addition to the supposed stability of returns and and high potential of returns, they want to give you capital to do something special and not buy stocks in a similar fashion to the overall market index.
They can do the latter themselves or give money to the many Beta-based funds to do it.
The downside is that being long-term profitable from Alpha-based strategies is notoriously difficult.
Most Alpha-based strategies die within 1-2 years. The opportunities will diminish as other market players catch on to what you’re doing.
You need to constantly innovate, find and implement new ideas and assets to be successful with Alpha-based strategies.
This is exhausting and tiring. Most successful retail traders who pursue Alpha strategies either give up after a few years or switch to Beta-based ones. And I’m not even talking about unsuccessful retail traders.
Risks
Risk is a measure of potential permanent losses.
We have dedicated a whole blog post on this so I shall just summarise key points here.
There are 3 ways to measure risks.
Risk measurement by quality of trading decisions.
Risk should be measured based on the quality of the trading decision.
Let’s say that if you roll a die and it lands 1, 2, 3, 4 or 5, you win $50. If you roll a 6, you lose $10.
You chose to play this game. You rolled a 6 and lost $10. This a good quality decision in spite of the loss.
Most decisions and event probabilities are dynamic so this method is subjective and has it’s own issues.
Risk measurement based on asset allocation and concentration
Don’t put all your eggs in one basket. Don’t hold or trade too much of assets that are correlated.
Risk measurement based on past performance
It is difficult to measure real risk based on past performance, but most people do that as it is convenient and they have no other standardised way to measure risk.
Risk can be measured using drawdowns, standard deviation of returns or some other fancy measure.
A drawdown is the biggest % drop in your portfolio.
To keep it simple, if you use drawdowns, your drawdown levels should be at most the same your annualised returns.
If you use standard deviation of returns, your Sharpe ratio should be greater than 1.
Consistency
As a trader, you might not mind losing money 11 out of 12 months if you are confident of making 2000% in that last month.
As an outsider watching you trade, he will freak out for 11 of out of 12 months.
In general, consistent returns is generally good for the following reasons:
- It is better for your trading psychology.
- Easy to monitor and mange (you will know fast when your strategy is not working).
- You can lever up and double your returns without taking on game-ending risks.
- You can raise funds easier.
- You can get a job at a proprietary trading firm easier.
At minimal, aim for 70% winning months.
Does demo account track record count?
No.
There are differences between demo and live accounts:
- Brokers will make it easy for you to get filled on demo accounts. The spread will be lower. They essentially want you to be profitable so that you’ll open a real account.
- Little trading psychology. People are more rational and trade better when the money isn’t real.
- No skin in the game. I can easily create countless demo accounts and trade differently to see which succeeds.
Related Questions
Can I get a job or raise funds from others using my track record? Yes you can. In fact, having a proven track record is the easiest way for getting into a proprietary trading firm, and it is the most important factor when raising funds. More info: “How to Raise Capital for my Trading and How Much Will I Make?“
