4 key metrics for measuring prop trading performance

Key takeaways

• Prop traders measure their performance using metrics such as return on investment (ROI), drawdown, Sharpe ratio, and risk-adjusted return.

• ROI is calculated by considering the capital invested, trade costs, risk appetite, profit/loss generated, and earnings relative to investment.

• Drawdown measures the peak-to-trough decline in an investment and indicates its financial risk. The length of the recovery window is important, and diversification can help mitigate drawdown risk.

• The Sharpe ratio measures risk-adjusted return by adjusting excess returns using standard deviation. It is important to consider limitations and match it with the risk-free rate.

How do prop traders measure their performance?

Prop traders measure their performance using a variety of metrics. These metrics include return on investment (ROI), drawdown, and Sharpe ratio.

It is important for prop traders to understand which metrics are best suited to their trading style and goals. This understanding allows them to accurately assess their performance.

To learn more advantages and disadvantages of proprietary trading companies, and how their work is organized - read the article: Proprietary Trading Explained

Return on investment (ROI)

A prop trader’s ability to measure their performance accurately is largely dependent on their return on investment (ROI). Calculating ROI provides traders with insight into the performance of their trading strategies, and is a key factor in assessing the success of their trades.

To calculate ROI, traders must take into account the amount of capital invested, the cost of their trades and the amount of profit or loss generated. This information gives them an idea of how much they are earning or losing relative to the amount invested. It also tells traders if their trading strategy is working or needs improving.

To illustrate, let's say a prop trader invests $100,000 in the market. After deducting all trading costs, if the trader's portfolio is worth $120,000, the net profit is $20,000. The ROI in this scenario is calculated as ($20,000 net profit / $100,000 initial investment) * 100, yielding an ROI of 20%. This positive ROI indicates not just profitability but also that the trader's strategies are effective.

However, if the trader's portfolio after costs is worth $90,000, this represents a net loss of $10,000, making the ROI -10%. This negative ROI signals a need for strategy reassessment and potential adjustments.

The higher the ROI, the more successful the trader is likely to be. Understanding their ROI lets prop traders make informed decisions when trading and adjust their strategies accordingly.

Profit factor

The profit factor offers a straightforward gauge of a trading strategy's effectiveness. It's calculated by dividing the gross profits by the gross losses over a specified period.

For example, if over a month, a prop trader made $50,000 in winning trades and had $25,000 in losing trades, the profit factor would be calculated by dividing the gross profits by the gross losses. $50,000 / $25,000 gives the resulting profit factor of 2. This indicates a profitable strategy, since two dollars were earned for every dollar lost.

In contrast, if another trader earned $30,000 but lost $40,000, their profit factor would be 0.75 ($30,000 / $40,000), signaling a strategy where losses outweigh profits. Aiming for a profit factor significantly above 1, like the ideal target of 2 or more, allows traders to ensure that their strategy is not only profitable but also has a good buffer for potential losses.

This metric helps traders not only to assess the profitability of their trades but also to compare the efficiency of different trading strategies under varying market conditions.

Drawdown

Taking into account the potential drawdown of an investment, along with the return on investment, prop traders are able to measure their performance and make informed decisions when trading.

Drawdown analysis is a key element in understanding the losses and gains of an investment, as it measures the peak-to-trough decline during a specific period. Typically quoted as a percentage between the peak and the subsequent trough, a drawdown can help determine an investment’s financial risk.

For example, a 50% drawdown requires a 100% increase to recover the former peak (e.g. a drop from $5000 to $2500 is a 50% drop, but the increase from $2500 to $5000 is a 100% increase). Therefore, it is important to consider the length of the recovery window before investing.

Having a well-diversified portfolio can help mitigate drawdown risk, but remember that some investments may take longer to recover than others.

Sharpe ratio

By measuring their performance using the Sharpe ratio, prop traders are able to assess the risk-adjusted performance of an investment. The Sharpe ratio (named by Nobel prize laureate William Sharpe) adjusts excess returns for risk using the standard deviation, and can be impacted by factors such as skewness, kurtosis, and leverage.

Simply put, Sharpe ratio measures whether the returns are worth the risks they require.

The ratio is most effective when returns are normally distributed, and may not accurately reflect the situation when returns are non-normally distributed. Understanding the limitations of the Sharpe ratio is essential for prop traders to accurately measure their performance.

Furthermore, the risk-free rate used in the Sharpe ratio should match the duration of the comparable investment to ensure a more accurate result. In conclusion, the Sharpe ratio is a useful tool for assessing the risk-adjusted return of an investment, but its limitations should be taken into account when using it.

Learn what strategies and techniques are used to control risk while trading in article: Mastering risk management in Forex trading

Best Prop trading firms

1

9.4/10

Go to broker

Your capital is at risk.

Minimum deposit:

$1

Review

Topstep is a leading proprietary trading firm offering traders the opportunity to trade futures contracts. With a unique two-step evaluation process, traders can prove their skills on a simulated account before potentially receiving funding for live trading.
Topstep offers three account sizes: $50,000, $100,000, and $150,000. Regular pricing starts from $165/month, with frequent discounts available. Traders can leverage up to 1:100 and access diverse futures markets, including stocks, commodities, crypto, bonds, and metals. Commissions and fees charged on the Trading Combine (simulation account) align with those on a live funded account, helping traders develop skills for real markets.
Topstep supports traders with educational resources, including free group coaching, to enhance their chances of success.

Pros/Cons

•Real trading accounts are financed by a broker, there is no need to invest your funds in trading.

•The company provides a wide range of free training materials, including free group coaching.

•You can contact the support team using several convenient methods.

•The broker offers a referral program for extra income.

•The company doesn’t offer bonuses, automated trading, or other passive income options.

•The support service works only on weekdays during set hours.

Study Review

2

9.2/10

Go to broker

Your capital is at risk.

Minimum deposit:

€155

Review

FTMO is a prop trading firm offering experienced traders the chance to manage a funded account of up to $200,000 with a wide range of instruments including Forex, stocks, indices, commodities, and cryptocurrencies. To qualify, traders must pass a two-step evaluation process.
Beginners may start with a Free Trial account which has the same trading conditions as the challenge ones. Long-term traders are free to use a Swing Account that has no restrictions on holding positions over the weekend or trading during macroeconomic releases. The company offers trading with the most popular platforms – MT 4/5, cTrader, and DXtrade. The leverage is up to 1:100.
Additionally, FTMO is recognized for its educational resources and continuous support.

Pros/Cons

•Quite low testing cost is €155.

•Classic platforms such as MT4, MT5, and Ctrader are familiar to many traders. For these platforms, hundreds of indicators, scripts, and advisers have been developed.

•The starting reward is 80%.

•Diversification of tariff plans. Candidates can choose a demo deposit from 10 thousand to 200 thousand US dollars. There are tariff plans that span from standard to aggressive trading.

•Leverage is up to 1:100.

•Strict requirements for the test period. The allowable maximum loss is 10% of the deposit amount. The target profit is 10%, for which 1 month is provided.

•There is no information about how the company is funded.

Study Review

Tips for improving prop trading performance

Improving prop trading performance is a continuous process that requires discipline, strategic planning, and an ongoing willingness to learn. Below you can find some key tips to enhance your prop trading outcomes:

• 1

  Keep a trading journal: A meticulous trading journal allows for an in-depth review of each trade, documenting the rationale behind trade decisions, the emotions felt, and the outcomes. This practice provides invaluable insights into personal trading habits, helping identify successful strategies and areas that require improvement.

• 2

  Develop a trading plan: Having a comprehensive trading plan sets a framework for decision-making and strategy execution. The plan should include entry and exit criteria, trading objectives, risk tolerance levels, and evaluation metrics. It establishes discipline and a structured approach to navigating the markets.

• 3

  Continuous learning: The markets are dynamic, and continuous education is key to staying ahead. Commit to learning new trading strategies, understanding evolving market trends, and adapting to economic shifts. This proactive approach ensures a trader’s methods remain relevant and effective.

Implementing these tips can enhance prop trading performance, leading to more informed trading decisions, better risk management, and ultimately, increased profitability.

Trading on a funded account can be a high-paying job. Learn what you need to start such a career in article: Is prop trading beneficial?