What’s Your Profit Factor? Here’s An Assignment For You…

  • February 7, 2005
  • TradingMarkets Editors

In my last article, I pointed out that there were several elements that should go in to devising a successful trading system. But of the components one should focus on, there is one that is of the utmost importance when evaluating a trading system. Our number one benchmark for constructing a sound, valid system is Profit Factor. In our view it is more important than percentage of winning trades or even total net profits.

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Profit Factor is simply defined as gross profits divided by gross losses. That’s it in a nutshell, but sometimes the simplest things hold the most value. So let’s imagine your trading system’s gross profit for the past year was $40,000 and your gross losses were $20,000. Your Profit Factor would be 2. ($40k / $20k = 2). The formula is simply giving you a reading as to the difference between your system’s gains as opposed to its losses.

A Profit Factor above 2 is outstanding. Obviously, the larger the number is, the better. For example: a Profit Factor of 3 means your net gains were 3 times greater than your net losses, and anything above 3 is unheard of.

Do you now see how important a component Profit Factor is when devising a valid trading system? This information can literally make or break a strategy and should always be considered before trading. Here’s an assignment for you: go back and research your current trading strategy and figure out its Profit Factor for the past year. You should shoot for a number above 1. The closer your number is to 2 the better, with anything above 2 being excellent.

At the Swing Trading College, nearly every method we teach you has a 10+ year Profit Factor of above 3. Some of the systems we will give you have Profit Factor readings of 10 or higher when applied to stocks. Good luck and good trading.

Steven Primo

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