Understanding trading metrics: win rate, profit factor, expectancy and drawdown

A single trade says little. Whether a trading strategy works over the long run only shows across many trades: How often do gains occur, how large are gains and losses on average and which setbacks happen along the way?

A few key metrics help to assess a trading strategy from different angles. The win rate counts the winners, the profit factor relates gains to losses and Expectancy combines both into the average result per trade. The R-multiple relates the result of a trade to the risk taken, the max drawdown shows the largest decline.

None of these numbers is enough on its own. This guide explains what each one measures, how they relate and which pitfalls come with small samples, partial closes and several currencies. The last part shows how Foliograph calculates the metrics directly from the journal.

Why profit alone says little

The realized profit of a period is the most obvious number, but it hides how it came about. The same total profit can result from many small gains and one large loss or from a few large winners and many small losses. For judging a strategy, these two cases make a big difference.

Metrics break the result down into parts that can be compared across periods, strategies and markets. Four questions are at the centre:

• How often? The win rate shows the share of trades that ended in profit.
• How much? Average win and loss, profit factor and expectancy describe the size of the results.
• Relative to risk? The R-multiple relates the result to the originally planned risk, for a trade with a stop the possible loss down to the stop.
• With what setbacks and swings? Drawdown, Sharpe ratio and Sortino ratio describe the path along which the result came about.

Reading win rate and profit factor together

The win rate is easy to understand and is therefore often overrated. A rate of 80% sounds high but says nothing about how large the remaining 20% turn out. Option sellers often reach high win rates because many positions end with a small gain while single losses can amount to several times that. Trend-following approaches often show the opposite picture: few winners that are clearly larger than the many small losses.

The profit factor adds size to the win rate. It divides the sum of all gains by the absolute sum of all losses, in short gross profit / gross loss. A value of 1.0 means gains and losses cancel out, values above it show a surplus of gains. A strategy with a 35% win rate can therefore have a higher profit factor than one with 75%.

Both numbers depend on what counts as one trade. When a position is closed in several steps or an option is rolled several times, the result depends on how these steps are grouped into one trade. This changes how many winners and losers enter the statistics. Fees and commissions also turn narrow trades from a gain into a loss.

Result per trade: in currency and in R

Expectancy combines win rate and size into one number, the average result per trade. The formula is: expectancy = win rate x avg win - loss rate x avg loss. A positive value means the evaluated trades were profitable on average, a negative one the opposite.

Expressed in a currency, expectancy depends on position size. Doubling the positions doubles expectancy without any change to the approach. The R-multiple solves this: it relates the result of a trade to the originally planned risk. For a stock trade with a stop, that risk is the distance between entry and stop multiplied by the position size. A gain of 2R means the trade earned twice the risk taken, -1R corresponds to a loss equal to the planned risk.

This requires a risk defined at entry for each trade. Without a clearly defined initial risk no clean R-multiple can be calculated. An evaluation that only covers part of the trades also only describes that part. For option selling without a fixed stop, expectancy in currency is therefore often the more meaningful number.

Drawdown: how deep and how long

The equity curve shows the cumulative result over time. Drawdown measures how far this curve is below its previous high and the max drawdown is the largest such decline in the period. It shows how far the equity curve fell below its previous high along the way.

Two more figures describe the duration: the share of time the curve spends below an earlier high and the recovery, the time from the lowest point to a new high. A drawdown over two weeks has to be judged differently from the same decline over a whole year, even when its maximum depth is identical.

An equity curve built from realized gains only contains closed trades. Open positions with unrealized losses only show up when they are closed. The decline on the account can therefore have been considerably deeper at times than that of the realized curve.

Risk-adjusted metrics: Sharpe, Sortino and Calmar

Risk-adjusted metrics relate return to its swings. The Sharpe ratio relates the average excess return, the return above the risk-free rate, to the volatility of the returns. Instead of the total volatility, the Sortino ratio only uses the deviations below a defined target or minimum return because upward moves are not a risk for most investors. The Calmar ratio divides the annual growth rate (CAGR) by the max drawdown.

These metrics come from fund analysis, where they assume daily returns on the whole capital and a risk-free rate. Calculated from a trading journal, they usually work with realized daily results. Days without a closed trade have to enter the series as zero, otherwise the annualization with the square root of 252 trading days comes out too high. Calculated from realized trading results instead of daily portfolio returns, Sharpe and Sortino are mainly suited for internal comparisons, for example between two years or two strategies, not for a direct comparison with funds or benchmarks.

For strategies with many small gains and rare large losses it helps to look at all three values together with the max drawdown. A high Sharpe ratio there can stem from a calm phase in which the rare large loss has not happened yet.

Breaking results down by strategy, holding period and mistakes

Metrics across all trades often mix approaches that have little to do with each other. Splitting by strategy, underlying, month, weekday or holding period is more revealing. Only then does it become visible whether, for example, short-term trades have a different win rate than positions held for several weeks.

Every split makes the groups smaller. With only 15 trades a win rate of 70% can be strongly influenced by chance. Comparing with the whole set therefore helps: does a group clearly deviate from the win rate and profit factor of all trades or is it within the usual range? Results of small groups should therefore be interpreted with particular care.

Your own mistakes are another dimension. When trades in the journal are tagged with mistakes such as a moved stop or an early entry, you can see how these trades differ from the rest. In addition, MAE and MFE show how far a trade moved against or in favour of the position along the way.

Realized or total: dividends, interest and currencies

Trading metrics usually refer to realized gains from closed trades. The account, however, also books other amounts: dividends, withholding taxes, interest on cash or margin and fees. A broader result calculation also includes dividends, withholding taxes, interest and fees. Foliograph shows this extended view as total return. It does not contain unrealized changes in the value of open positions. Deposits and withdrawals are not part of it because they change the capital employed and are not a return.

Trading in several currencies requires a common base currency for the evaluation. A gain in US dollars and a loss in euros can only be added after conversion. The result also depends on the exchange rate used for the conversion, for example the rate on the closing day or the current rate. The difference grows over longer periods with strong currency moves.

Frequently asked questions

Terms on this page

• Base currency (Reporting currency)
• CAGR (Compound annual growth rate)
• Calmar ratio (Drawdown ratio)
• Expectancy (Average result per trade, expected value)
• Hedge Budget (Hedge cost ratio, hedge budget share)
• MAE and MFE (Maximum adverse excursion, maximum favorable excursion)
• Max drawdown (Maximum drawdown, MDD, time in drawdown)
• Profit factor (PF)
• R-multiple (R, result in R)
• Roll and Roll Efficiency (Rolling)
• Sharpe ratio (Reward-to-variability ratio)
• Sortino ratio (Downside risk-adjusted return)
• Realized P&L and total return (Realized profit, total return)
• Win rate (Hit rate, percent profitable)

All terms in the glossary

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All market and analytical information is provided for educational and analytical purposes only and does not constitute investment advice or a trading recommendation.