Trade Efficiency

Trade Efficiency

Trade efficiency is a performance value that identifies whether a stock or other trading product was bought or sold at a good price. By examining trade efficiency, traders can improve their trading systems by choosing better buy and sell points.

To calculate trade efficiency, both the buy price and sell price must be known. In addition, the highest and lowest prices reached during the holding period must be available. Since the perfect price for a long trade would be to buy at the lowest price and sell at the highest price during that time frame, the trade efficiency can be determined as a percentage of that perfect price.

Trade efficiency is often divided into several statistics. Entry efficiency identifies how close the buy price came to the perfect price. More specifically, if the price continued in an adverse direction after the trade was entered, this will result in a lower entry efficiency. Likewise, the exit efficiency identifies how close the sell price came to the perfect price. If the sell price is significantly lower than the highest price, a lower exit efficiency will be identified. Finally, the total efficiency evaluates both the entry and exit, identifying how closely the entry and exit came to the perfect buy and sell prices during that time frame.

The trade efficiency is typically displayed as a percentage, with 100% identifying perfect efficiency. While many software packages display the trade efficiency within a list of trades, many also display it on a chart. One of the more powerful software packages is StrataSearch, which offers trade efficiency as well as a host of other tools to aid traders in building profitable trading systems. By viewing trade efficiency on a chart, traders can quickly get a visual overview of their trading system's entry and exit efficiency. This will help identify if improvements to the trading system are still needed.

The following formulas are used to calculate trade efficiency:

Long Positions:

Entry Efficiency: (High Price - Buy Price) / (High Price - Low Price)
Exit Efficiency: (Sell Price - Low Price) / (High Price - Low Price)
Total Efficiency: (Sell Price - Buy Price) / High Price - Low Price)

Short Positions:

Entry Efficiency: (Buy Price - Low Price) / (High Price - Low Price)
Exit Efficiency: (High Price - Sell Price) / (High Price - Low Price)
Total Efficiency: (Buy Price - Sell Price) / (High Price - Low Price)

Once the trade efficiency is known, trading system adjustments can often be made to improve overall performance. For example, if there is poor entry efficiency, adjustments should be explored to enter trades at a point when the buy price is closer to the lowest price. This will create improved trade efficiency and therefore better system results. Similarly, if a poor exit efficiency is identified, selling at an earlier point near the highest price will improve the trade efficiency and therefore the system performance.

A noted flaw of the trade efficiency calculation is that the sequence of high and low prices is not considered. For example, for a long trade, it is possible that the high price was reached before the low price. In such a case, buying at the low price and selling at the high price would not have been a possible scenario. While such a flaw is inherent in the trade efficiency calculation, it is minimized when the holding periods of the system are shorter. In particular, longer holding periods provide additional time for the stock to go up and down multiple times, making it difficult to identify whether the high price or the low price was hit first. Shorter holding periods, however, offer less time for the stock to go up and down multiple times. For this reason, trade efficiency may be more accurate when the holding periods are shorter rather than longer.

StrataSearch uses trade efficiency as one of its many features for identifying successful trading systems. For more information on StrataSearch, click here.