Usefulness of normalized profit factor and average recovery factor

Trading Discussion
1

Profit factor and recovery factor are standard trading statistics.

  • Normalized profit factor
    • Definition: sum of (each win / position size) / sum of (each loss / position size)
    • This is profit factor normalized over position size. It is like profit factor when position size is fixed.
    • This likely reflects a trading system’s performance better than profit factor.
    • Profit factor gives more weight to larger trades. Normalized profit factor gives equal weight to every trade.
  • Average recovery factor
    • Definition : net profit / average drawdown
    • Average drawdown’s definition: sum of each drawdown at each point in time / number of all data points for the duration of time considered.
    • Recovery factor is net profit / total drawdown
    • Total drawdown doesn’t reflect frequent drawdowns. Average drawdown goes up if there are frequent drawdowns.
    • Two trading systems may have the same recovery factor but different average recovery factors because another trading system has more frequent drawdowns.
    • Most people prefer equity curves with less frequent drawdowns. Average recovery factor is likely to be a better trading statistic than recovery factor.

Do you think normalized profit factor and average recovery factor are useful?

2

Maybe. You can dive down many rabbit holes in life, but I learnt one important thing from a 21 year old millionaire I met 25 years ago. He was a builder. He explained “when you have finished a job, it is important that you always have more money in your pocket than when you started”.

Whilst he had made his money from other people’s labour, I took this philosophy with me for the next 30 years. In Forex (and trading in general), I have always decided a timeframe in which I needed to demonstrate whether I had more or less money than when I started. Until the last 5 years, that timeframe had been too short, typically less than a year. But it is a good start. In practice, I try to work out if I am better or worse off each three months, and formally each year only. It helps to normalise the analysis paralysis that can grip you if you try to make things a lot more complicated than they need to be.

4

I don’t intend to dive further into trading statistics. I recognized any more will result in analysis paralysis.