The efficiency trading statistic tracks how well we follow our Trading Plan rules. It lets us know how well we are trading relative to a more objective measure than simply how we “feel” we’re trading.
I first learned Efficiency from the late Van Tharp.
In its simplest form, say I make 10% on a trade because I exited early for no good reason other than I’m afraid to lose, for example. I didn’t follow my exit rules. The rule-based outcome produced a 20% profit.
That is 50% efficiency. I got 50% of what I was supposed to, as an example.
If I got out for a 15% gain and the strategy produced 23%, that is 65% efficiency (15/23).
If you don’t have a strategy or Trading Plan, EVERY TRADE IS A MISTAKE.
An efficiency score tells us basically how much our emotions are impacting our results. Rationalizations can creep in and we may say “I was tired” or “Conditions changed“. If that is the case, you need rules for those types of situations.
I actually have rules for if I’m feeling emotional, uncertain, or if conditions change. If you are constantly rationalizing that means you’re inefficient in following your system OR you have too many holes in your Trading Plan. Something is wrong, period.
If we track common “inefficiencies”/mistakes and the emotions involved, we can then work on those areas to improve. It creates a line in the sand where we can’t manipulate ourselves. The number shows us where we stand versus our system…and we then have some tangible data for closing the gap.
Efficiency numbers fluctuate but over many trades you can see where you are at and incrementally improve it by sticking to the rules. You improve efficiency and results not by trying to “win” but by following your rules.
Improve efficiency. It’s critical for trading success.
I have provided some further insights on Efficiency below, but they are just insights. There is no perfect way to use it or calculate it. It is a tool. Decide how you want to use it so that it helps you and allows you to track your progress.
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Calculating the Trading Efficiency Statistic
Calculating the static can be very straightforward in some situations, but may need to be “estimated” in other situations.
For example, if the rules provided 5R during your day trading session, but you only got 3R, that is 60% efficiency.
But what if you held a trade longer than you were supposed to and actually made 6R instead of 5R?
Well, some people would give themselves a pat on the back, but it is not a good habit to violate your rules, even if you win. If you want to hold some trades for bigger profit….MAKE RULES for that situation or condition.
So I would give an efficiency score of 80%. Basically, you make 1R in mistakes. The actual is 5R, so a 1R mistake is 20% of that. It was a 20% mistake, 80% efficient.
If you track percentages or dollars instead, it works the same.
Say you should have had 14% in gains or $2100 in profit. If you only make 11%, the efficiency score is 76%. If you make $2300 instead of $2100, something was maybe a little off, so your efficiency is 90% ($200 in mistakes / $2100 is a 10% mistake so you were 90% efficient).
What is a Good Trading Efficiency Score?
There will always be tiny inefficiencies in trading. Anything near 80% or above is great.
Tiny efficiencies happen because:
- Position size may be slightly off, we may not even be able to get an exact position that matches exactly the risk we are willing to take on.
- Slippage happens on trades, which will affect profits and losses. If we lose more than expected on a trade (or make less) that affects efficiency. You may have followed the rules, but it is still important to see how slippage affects your results.
- We get distracted and miss trades or get impulsive. Again, it’s good to know how much that affects results.
So perfection isn’t the goal. We just want to be improving so that our results closely match the system we are trading.
If the system sucks, that’s a different issue. Create strategies you do like.
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How to Improve Trading Efficiency
Generally, poor Efficiency is due to trading mistakes. We took trades we weren’t supposed to, exited early, held onto a loss past our stop loss point, or didn’t take a trade we were supposed to, as some examples.
Improving efficiency means we need to reduce the number of mistakes made. It can seem overwhelming, so just focus on one mistake at a time. Isolate it down to one thing which causes most of the issues. Then just try to improve it incrementally.
If you had 10 impulsive trades last month don’t assume you will be able to get rid of them all instantly. If you have fewer impulsive trades next month that’s an improvement. Once you have minimized that mistake, move on to another one. This way you actually make progress; if you try to solve everything at once you will get nowhere.
Here are some articles on how to reduce mistakes. Remember, these are mental mistakes. The strategy produced a certain result and you didn’t, so it’s not the strategy’s fault. That is why all these mistake-reduction exercises are mental:
- Bring focus to How and Why you will do something instead of only thinking about results.
- Eliminate (via reduction over time) Impulsive Trades by having a pre-trade routine and Commentating the price action.
- Isolate the part(s) of yourself that sabotages you. Find out why and do a Parts Negotiation with it.
- Stop relying on willpower and discipline which can fail at critical moments. Instead, work on developing your identity, who you are and want to be, with Identify Work.
If poor efficiency was due to slippage, but you followed your rules, note that it happened and maybe there is a way to avoid such big slippage in the future. Or maybe you decide it was an isolated incident, your risk is controlled, so you don’t think much about it. If you are following your rules, efficiency will improve again.
By Cory Mitchell, CMT
Disclaimer: Nothing in this article is personal investment advice, or advice to buy or sell anything. Trading is risky and can result in substantial losses, even more than deposited if using leverage.