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August 12, 2012

Exit Efficiency Ratio

No-legacy-notion

The amount of literature that focuses on trade entries seems to have a positive correlation with why traders talk about entries. It seems bizarre that entries are discussed a lot more than exits, when exits are the primary source of profits. Entries should only be looked at as something that starts a position, not as something that is responsible for profits. Exits are one of the most overlooked elements in trading.

Imagine there is a way to isolate exits and see how much profit you have obtained from that exit. The Efficiency Exit Ratio does this. It was created by Chuck Lebeau, who designed it to isolate exits, and quantify whether your exit was able to get the maximum amount of profit from your trade.[i] It isolates the exits from the rest of your trading system and measures whether you have exited the trade at the best moment.

To calculate the Efficient Ratio, we take the real gross profit and divide by the extended holding day profit.

Say you bought IBM at $54 a share, and you bought 100 shares. You then exited IBM in three months’ time, and you sold it for $78 a share. Minus commission you have a gross profit of about $2,385.

Commission amounted to about $15. I know that is high, but this is hypothetical. The trade lasted three months. So that works out to about 60 trading days. Our holding period was 60 days. Now we double our holding period to about 120 days.

We examine another 60 days after we exited the trade and look for the highest lpeak, since we traded long. If we shorted a trade, and it was profitable we would look for the lowest dip. Say within our imaginary holding period of 120 days the best place to exit the trade was at $86 a share. After the commission we could have exited and had a gross profit of $3,185.

To calculate the Efficient Ratio, we take the real gross profit and divide it by the extended holding day profit. $2,385 divided by $3,185 would give us an exit efficiency of 75%. We captured around 75% of the full profit from our exited trade. The holding period seems to be a variable that can be disputed.

Why double? The original holding period can be multiplied by different factors. To estimate the best holding period, I would use the average of the holding days for all profitable trades. Some might ask why you would want to make the holding period longer? In my own experience I have tended to exit trades a lot faster than I should have.

[i] Lebeau, C. (2007). Retrieved 7 11, 2012, from tradeducation.blogspot: http://tradeducation.blogspot.tw/2007/01/measuring-exit-efficiency.html



About the Author

Trendmovements
Trend Movements is the brainchild of Tahric Finn and Chad Grant. Both men are active traders in the markets, and are willing to discuss financial market trends and beliefs at any time. They believe we should all have some knowledge of how finances work. Even you! Ya you! The guy (or gal) reading this right now!




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