The same
is true in actual trading. Exits determine the outcome
of our trading and have more impact on the results than
any other factor. Yes, exits are even more important
than money management (position sizing). Not even the
best money management strategy can make a losing system
into a winner but a minor change in the exit strategy
can work miracles. We quickly discovered this years
ago when attempting our first tests of indicators. We
found that even a slight variation of the exit strategy
used in the testing would affect the number of trades,
the size of the winners and losers, the percentage of
winners, the drawdown and the total profitability. We
set out to test entries but quickly learned that in
most cases we were testing exits because the entries
had little if anything to do with the results.
We eventually began isolating, as best
we could, our testing of entries and exits. We now test
entries based solely on the percentage of winning trades,
exiting after a specified number of bars. This method
of testing entries is based on our conclusion that the
only purpose of entry timing is to get the trade started
in the right direction as accurately as possible. Everything
that happens after that has nothing to do with the entry
because the outcome of the trade is now in the hands
of our exit strategies. We want our entries to accomplish
only one purpose and that is to get our trades started
in the right direction as quickly as possible and this
function is easy to measure. The higher the winning
percentage after a few bars the better the entry. But
how do we measure the efficiency of our exits? How can
we tell if one exit is better than another? What is
a good exit? What is a bad exit? Which is better: exit
A or exit B?
To try and quantify the relative merit
of various exits we created the Exit Efficiency Ratio
and contributed an article on this topic to Futures
Magazine several years ago. (I'm trying to get this
Bulletin out today and I am sorry that I don't have
the specific reference for the article in front of me.)
For those of you using Rina/Omega's
Portfolio Maximizer software you should be aware that
the Exit Efficiency Ratio that we wrote about is not
the same calculation presently used in Portfolio Maximizer.
Here is our original version of the Exit Efficiency
Ratio.
You need to start by keeping or creating
a record of your winning trades. You must also keep
a record of the total number of bars in the trade from
entry to exit. As an example, lets assume that we made
a profitable trade that lasted 12 bars from entry to
exit and the trade captured $1500 of gross profit.
The next step is to go back and look
at our entry point and 24 bars of data after our entry.
Our theoretical holding period is now twice the actual
holding period. We then use perfect hindsight to identify
the best possible exit point within this theoretical
holding period. Don't be shy, pick the absolute best
tick for the theoretical exit and compute the theoretical
gross profit. In this case lets assume that somewhere
in the period we could have exited the trade with a
$2500 profit at the absolute high point of the theoretical
trade.
The Exit Efficiency Ratio is then calculated
by dividing the actual gross profit by the theoretical
gross profit. We divide 1500 by 2500 to arrive at an
Exit Efficiency Ratio of 60%. This tells us that we
actually captured 60% of the profit that might have
been possible for this trade.
The Portfolio Maximizer formula for
exit efficiency measures only the efficiency during
the actual holding period. I'm sure this is for practical
reasons because the trade by trade listing used for
most calculations would not include data outside the
range of the holding period. |