Beating the benchmark(s) as a trader is easy. The question should always be how efficiently was alpha produced. Or said another way, how much risk exposure did one have to take to produce said alpha.
In fact, I would argue that as an active trader or investment manager, any account or AUM being managed under 10m dollars the appropriate benchmark should be beat by at least 5x on an annual basis, and on years when the benchmark is down produce a return that is AT LEAST 2x positive of what the benchmark does to the negative side. In reality, positive returns on a year that is clearly negative for the markets can and should produce significantly more positive returns given the way volatility regimes work.
Our minds are trained to focus on win rates, and on the surface this is not wrong, but it is highly dependent on the size of wins versus the size of losses also. This is why profit factor becomes far more important in most instance when evaluating how efficiently a strategy performs.
Along with this there are timeframes to contextualize the efficiency of a strategy. For us, we focus heavily on the weekly net result of all trades taken within our strategies. Why?
Because the vast majority of the trades taken have an expiration on the options the same week (front-week). And now with daily expirations on the Index and Index ETF options, this provides even more granularity into capture quick burst of alpha and tending to the risk management side (hedging).
To use a football analogy think of each week as a single game. Each trade as a set of downs or even a single play. If your team is on offense and takes a sack for a 10 yard loss is that the end of the set of downs? No. Or if the set of downs is a 3 and out and you have to punt (manage risk), does that mean you suck and the game is lost? No.
Winning the game is all that matters. A team could 'lose' 3 of the 4 quarters and still win the game. In fact, trading is better in the regard that let's say a team scores 0 points in 2 quarters but 20 points in the other 2 quarters and wins the game the two scoreless quarters become insignificant. Oh, and one key thing that trading has that football (or any other sport) does not, a game where a team scores 50 points in a single game but only needed 20 points to win, those excess points basically carry over to the following week and for the the remainder of the season.
To take it a step further, there will be games (weeks) that result in a loss. Is the season done? Nope, not even close.
The point to all of this is whether it is utilizing our strategies, ones with another service/ trader, or ones of your own, focus on the net result relative to the timeframe being traded. For a day trader this would be day over day, and I would even argue still week over week would be more important. Doing Swing Trades? Maybe month over month may be a good evaluation point.
An example of this for us is week over week. While it obviously requires a positive profit factor on all trades to be profitable, we expect over time our strategies to produce a profit factor at the trade level of 2:1 or greater with win rates not much over 50%, and generally less than 60% for let's say a 1,000 trade sample size. Since this includes hedges (which are generally a fraction in size of the core positions) this is fairly impressive. But what's more impressive is week over week we expect a profit factor on a weekly basis to be well over 5:1, if not 10:1 or greater, and secondly and of less importance a weekly win rate of 80% or greater.
Context is king. This doesn't mean lie to yourself but always evaluate a strategy in the proper context. It can and will change the way you view things and greatly mitigate, if not alleviate, emotions in trading.
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