CHAPTER 1

Potential Profit as a Measure of Market Performance

The goal of trading is to make money, and for many, profits are the best way to measure that success. It is one of the most important performance characteristics of trading. In this chapter, I would like to emphasize that in contrast with ordinary profit, potential or maximum profit—the central subject of this book—does not deal at all with the activity of an individual trader. Potential profit and the strategy producing it are market properties. Along with this, I will write a C++ program computing Pardo's potential profit.

PROFIT AND POTENTIAL PROFIT

What does a profit tell us? Is it a characteristic of the trader's skills? To some extent yes, but that is not all. The profit is a result of interaction of the human with the market. It characterizes the trader as well as the existing market conditions.

If we apply a mechanical trading system to several historical intervals of market data and get the average annualized return on investment, what does this value mean? Is it a system characteristic? In many respects yes, but not exactly. This value is a measure of both system and market performances.

If a developer says that his system produced a 60 percent return on investment, does it mean that the system is good? To make the hidden sense obvious, I will reformulate the question. Can we expect a 60 percent return on investment if we apply the same system to a flat market? One can argue that such markets luckily do not ...

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