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TFC Commodity Trading Forum

Statistical Validation: The End Game In Education *LINK*

Without a static trading plan that can be benchmarked in different markets over different time periods, your attempts at trading education are, as Connie, a trader in Florida put it after sitting thru several trading education programs, "like riding a merry-go-round". At first it's fun and exciting, but after a time you figure out that you're just going around in circles.

A static trading plan, one that does not change, is important because you need that continuity to be able to benchmark the trading method you've chosen to study. When you see a trade signal you need to know from the onset what your odds of success are based on the method's winning percentage and risk/reward to date. Without that critical information on-hand you're stuck on the merry-go-round.

The process of validating a trading method by recording its performance is called benchmarking, and without it you will find it difficult to take the risks a trader needs to take to be successful over the long run. The benchmark, usually in the form of a spreadsheet that records the entries and exits of a method - see Figure 1 -- is essential for many reasons. First the benchmark assures that you know how the method works, second that the method delivers satisfactory results, and thirdly it is great for comparing your own trading performance to it. If you are not trading as well as the benchmark then you are not following your trading plan and this comparative analysis will highlight where you are deviating.

(click to enlarge)
Figure 1. Benchmark spreadsheet for RTT Ratio Method in USDJPY on 4-hour time-frame over a 6-month period

The benchmark is by definition hypothetical because it accomplishes two aspects of trading nearly all of us have difficulty in doing. It records every trade a method produces over an extended period of time - the benchmark does not sleep - and it manages those trades to the letter of the plan. Because the benchmark is purely mechanical is provides a more accurate representation of a methods performance than an individual trader can.

The benchmark is the bottom line for gauging the success of your trading plan and method, or anyone else's. So before you decide to demo trade, or before you even decide to trade period, you need to be able to produce a trading plan that generates a desirable benchmark, or find a reputable educator to provide one for you.

Also, if you alter your existing trading plan, it is considered a new plan, and you need to start a new benchmark spreadsheet.

To see Jay Norris highlight trade set-ups and signals in live markets on Mondays & Thursdays go to: Live Market Analysis. Jay is the author of "The Secret to Trading: Risk Tolerance Threshold Theory".

Trading involves risk of loss and is not suitable for all investors.