Forex signals are a great way of earning a return in forex without too much continuous effort, having said that, you do need to put a significant amount of effort into selecting a good signal in to start with. In this quick article we will discuss a couple of the key metrics to look out for and the hallmarks of solid forex trading signals.
Forex Trading Signals Need an Edge
You’ve probably heard the old gambling adage “the house always wins”, this is because most games of chance have been designed with a small house edge. Some players will win, some players will lose, but the house will always make it’s 2%. The key to profitable forex trading, whether manual or automated, is having an edge.
The two metrics that determine your edge in forex are your Win % and your Average Win/Average Loss (risk:reward). In order for a forex signal to have an edge and hence be profitable, it must have either a) a win rate exceeding 50%, b) Average Wins greater than Average Losses, or the best one c) a combination of the two.
If you find a system that wins more often than it loses, and it’s average winning trades are bigger than its average losses, you know you’re on the right track!
Look for Forex Signals with Average Returns Exceeding Maximum Drawdown
This is probably one of the most important metrics when it comes to assessing the quality of a forex signal, yet for some reason it is widely under used in the standard analytical suites. The metric can take many forms, ROMAD (Return Over Maximum Drawdown), MAR ratio, CALMAR ratio etc, but they all essentially tell you the same thing: whether a given strategy’s returns are greater than it’s drawdowns and to what degree.
Don’t worry about all the confusing names mentioned above, simply look at the return of the forex signal over the past 12 months and compare that to the largest historical drawdown. Ideally, the annual return should be double the maximum drawdown and the bigger the better. Think of this metric as risk:reward on a global scale. If you could experience a drawdown of 20%, you want to ensure your potential return over the year is 40%!
Look for Forex Signals with a Solid Track Record
Edge and return to drawdown ratios are great, but they are near meaningless if they don’t have the track record to back them up. The bigger the sample size, the more reliable the data. Avoid signals with less than one year of track record and signals with less than 50 trades and bear in mind this is a minimum qualifier, the longer the time period and greater the number of trades, the more reliable the data set. It is also to extremely important to remember that no matter how much historical data you have or how reliable it is, markets are in a constant state of flux and future performance is almost guaranteed to diverge from what has occurred in the past.
We hope you have enjoyed this short piece on the hallmarks of a solid forex signal. Putting time and effort in when selecting a forex signal from the best forex broker can save you a lot of trouble down the track (and make you a lot of money too!)
Source: Vantage FX Blog