Inorder to evaluate a trading system, the developer will run the system against historical data to determine how it would have performed during the specified period. This is called backtesting and is a valuable tool for determining the efficiency of any trading system. Many trading platforms allow you to perform such performance tests and you can produce what is called *Strategy Performance Report*.

The report includes a variety of performance metrics. The traders are often confused with how to evaluate the trading system using these metrics. Actually speaking not all those metrics are required to decide the performance of any system. I have come out with 3 metrics that is enough to evaluate a trading system. They are

1. Profit Factor

2. %Profit Trades

3. Maximum Drawdown

**1. Profit Factor**: Profit Factor is determined by using the formula (**Gross Profit/Gross Loss**). Gross Profit is the sum of all profits (win trades) and Gross Loss is the sum of all Loss (loss trades). For eg.,

Gross Profit = 10000

Gross Loss = 5000

Then Profit factor = 10000/5000 = 2.0.

In simple terms it means how much you will earn when you risk 1 unit of currency. In the above example for every 1($ or Rs) risk you earn 2 ($ or Rs).

A profit factor of more than 1.28 is a good one. A pf of below one is a loss making strategy.

**2. % Profit Trades**: It is also known as the probability of winning. It is determined by the number of winning trades divided by total number of trades.

% profit trades = Winning Trades/Total Trades

The ideal value for this metric depends on the style of trading. If the strategy is for long trend following one, then a 40% profit trades would produce good profit. However if the strategy is for scalping and intraday then % profit trade must be a high value in the order of 70 to 90.

**3. Maximum Drawdown**: This metric measures the maximum risk that a system can generate. If the largest amount of money that a trader is willing to lose is less than the maximum drawdown then the system is not suitable for him.

Happy Trading