The Importance of keeping a Trading Journal

A trading journal is a detailed record of all of your trades. It should be in the form of a spreadsheet so that you can analyse the data easily and as a minimum, you should include the following information:

• Trade entry
  • Date and time
  • Entry Price
  • Position size
  • Buy or Sell
  • Initial stop loss (and trailed stop losses if relevant)
  • Initial target level (and additional target level if relevant)
  • Initial risk amount (in actual monetary terms)
  • Target reward amount (in actual monetary terms)
  • Reason(s) for taking the trade (these can be brief)
• Trade exit
  • Date and time
  • Exit Price
  • Profit or loss achieved
  • Reason(s) for exiting the trade

Why Keep a Trade Journal?

For me, it is absolutely essential to have an accurate record of your trading performance, otherwise you’re effectively trading blind.

Your trade journal will provide an accurate and complete historical record of your trading performance. It is your personal performance database, giving you the opportunity to analyse your trading performance in detail.

Depending on how analytical you want to be, you can glean a huge amount of useful information from your journal which you can then use to refine and improve your trading strategy.

With this data to hand, you can assess:

• Which assets make you the most profit (or loss)
• The duration of your best trades
• Which days of the week are most profitable for you to trade
• Whether long or short positions work better for you
• The number and frequency of your trades
• Your average initial risk per trade
• Your largest and smallest risk per trade
• Your average profit/loss per trade
• Your Hit Rate (percentage of profitable trades)
• Your initial and final risk/reward ratios (RRR)

Benefit 1 - Help confirm your trading methodology

Using your historical performance data, you’ll be able to analyse just how well your trading system is performing in changing market conditions. It will answer questions such as:

• How did my strategy perform in trending markets?
• How did my strategy perform in sideways, range-bound markets?
• How did my strategy perform over different time-frames?
• How many trades hit target and how many hit stop losses?
• Were my stop loss orders too close or too far away?
• What was my maximum drawdown on my portfolio over a particular period?

Note that a partially-filled trading journal is worse than useless! If you’re going to keep a trade journal, you need to record EVERY trade in all its detail. Your trade journal must be fully comprehensive, and ALWAYS kept accurate and up-to-date.

Benefit 2 - Help you to stick to your trading plan

Not only should a good trade journal keep a detailed record of your trading data (i.e. numbers), but it should also provide descriptive information for each trade. This will help you to understand why you took certain trades, and will help you to recognise any mistakes:

• What criteria were used to set up the trade?
• How (and at what price) do you trigger and execute the trade?
• Where do you place your stop loss and why?
  • How much are you prepared to risk?
• Where do you place your profit target(s) and why?
  • Are your targets realistic and achievable?
• How do you manage the trade as it progresses?
  • Trailing stop loss
  • Take some profit on the way to your target
  • Maybe add to winning positions, etc.

In other words, your journal becomes a way for you to record your thoughts in words and numbers, and makes it possible to convert wishful thinking into practical reality. It forms the basis of a method for planning your trade… from which you can then trade your plan.

Benefit 3 - Help you to stay positive and constructive

Another useful feature of a trade journal is that it helps you to maintain your positivity by keeping your trading processes structured and constructive. As you learn how to trade your plan consistently, you will develop a greater level of confidence. Your profitable trades will feel less random, and your losses will be "planned for" so they won't impact you psychologically in a negative way.

Confidence is an extremely important psychological factor in trading – but overconfidence can be extremely damaging too. You should aim to avoid as much emotion as possible, especially fear, greed, and revenge, all of which are natural, hardwired emotions in most human beings. If you are winning, you want to win more; if you are losing, either you want to jump back into the market to get revenge (i.e. get your money back), or your fear and panic may take over as your account starts to dwindle.

Trade Journal Construction

Your trade journal should be comprised of three main sections:

1. A chronological list of trades including all details of trade entry and exit (see the first section of this article for the list of items to include). This is best done within a (relatively simple) Excel spreadsheet. Make sure to capture as much data as possible to enable you to perform a wide range of analysis on your trading performance.

2. A more detailed report including a screenshot of the actual chart you used to determine the trade, indicating your entry level, stop loss and profit target levels clearly marked on the chart. In addition, you should (briefly) record your reasons for taking the trade:

• Fundamental Reasons - For example: "US dollar is expected to strengthen due to the Fed's policy of looking to raise interest rates as the US economy continues to recover."
• Technical Reasons – For example: "US dollar is in an uptrend, but has retraced back to a major support level – strong rebound expected from here to continue the trend."
• Sentimental Reasons or Market Psychology – For example: "Traders are reducing appetite for risk based on the lacklustre global economy, although the U.S. economy looks more healthy (strong GDP data and positive job creation numbers)."

3. Once each trade is closed out, include a summary of your completed trade, with another screenshot of the chart after the trade has been completed. Outline the reason for closing the trade (e.g. hit target, hit stop loss, manual exit). Since the trade is now complete, you have a lot more information than you had at the start, so use this information to review your trade and then write down any lessons learned.

Note that if you have more than one trading strategy, you should set up a separate trade journal for each one. Do not mix different trade plans in the same journal. Using separate trade journals will enable you to compare the performance of different strategies against each other in different market conditions. If you have more than one strategy and combine ALL of your trades into one big journal, then your results will be derived from too many variables and it will be very difficult to reach any firm conclusions about any of your strategies.

It’s worth noting that most online brokers provide the facility to automatically view (and download) details of your trading history, including your commission amounts and roll fees. However, they won’t provide all of the information you need to complete your more comprehensive analysis of your performance, and doing it yourself keeps you more closely in touch (and in tune) with your day-to-day trading activities.

Trade Success Expectancy

Once you have completed at least 50 trades (the more, the better of course), you can calculate the expectancy or reliability of your system. A positive expectancy indicates a profitable strategy, while a negative expectancy illustrates a losing strategy.

Here is the expectancy formula – it looks scary, but should be easy to plug your numbers in:

E = {([1+PLR] x HR) – 1} x 100

PLR = Profit-to-Loss Ratio = Average profit/Average loss

HR = Hit Rate (percentage win ratio)

Example 1:

• You complete 50 trades, with 20 wins (avg. £180 gain) and 30 losses (avg. £100 loss)
• PLR = 180 / 100 = 1.8
• HR = 40% = 0.4

Expectancy, E    = {(2.8 x 0.4) – 1} x 100

= {1.12 – 1} x 100

= 12%

A positive 12% expectancy means that your trading strategy is expected to return 12% profit in the long term.

Example 2:

• You make 50 trades, with 30 wins (avg. £100 gain) and 20 losses (avg. £160 loss)
• PLR = 100 / 160 = 0.625
• HR = 60% = 0.6

Expectancy, E    = {(1.625 x 0.6) – 1} x 100

= {0.975 – 1} x 100

= -2.5%

A negative 2.5% expectancy means that your trading strategy is expected to lose 2.5% in the long term.

Once you know your system's expectancy, you can trade with more confidence in the knowledge that your trading strategy has a positive edge. Confidence is the key to execution, since lack of confidence can lead you to:

• Hesitate when executing trades, even if your trade plan has given you a trading signal
• Start to second guess yourself
• Become too emotionally involved at the point of trade, or
• Spend too much time on your analysis, looking for extra confirmation before committing to a trade (analysis paralysis)

In summary…

Keeping a detailed record of your trading statistics enables you to understand exactly how well (or badly) your trading strategy is performing.

Once you have the data, you can perform detailed and useful analysis on your trading performance to identify what is good and bad about your trading process. It helps you measure how well you have executed each trade, and most importantly it provides information to enable you to develop and enhance your trading strategy.

It keeps you 100% honest in terms of your past performance and future expectations – don’t forget, the numbers never lie!