Lake ratio use, logic and formula

The lake ratio is a simple to understand ratio for use in measuring performances of trading systems and the trading account of a trader or fund manager.

This formula was I believe first created by Mr Ed Seykota a great trader with a razor sharp mind. Featured in the highly regarded book Market Wizards volume 1 Video below shows the Precision Probability Index trading system which achieves a good lake ratio. Shown here with speeded up data Indroduction and concepts of the lake ratio The lake ratio is a simple to understand ratio for use in measuring performances of trading systems and indeed the trading account of a trader or fund manager. This is based on the equity curve generated by the trader or the system. In recent times it has become more popular as a tool of institutions for use in measuring traders risk profiles v profits. Simplicity = Beauty You can find out your own personal lake ratio value by trading a few sessions of the Trading IQ Game and then viewing the trade report at the end of the session ( you must be logged in to receive the trade report ) The three main areas which are used to make the measurement calculation are Growth rate of account Depth of draw down of that account ( the greater the percentage of draw down the deeper is the water ) Time that the account is underwater ( the longer the duration of the draw down the wider the water ) The ideal lake ratio which all fund managers seek to achieve is the improbable 0.00 and the higher the number measured the worse the performance. Here are some examples Example No1 In the example below we can see the red area represents the growth of the account and this is referred to as "mountain area" when all the cubes of the mountain area are added up we get 4900 The lake area is counted by adding up the area of the blue area using the right column to note the balance of the account Thus lake area = 600 The to get the lake ratio we simply take the lake volume divided by mountain volume 600 / 4900 Lake ratio = 0.1224 ( very good ) Lake ratio formula = lake divided by mountain. Calculating area of each is best done by sampling each bar or day or which ever frequency of data is used. Example No2 In the example below we can see the red area represents the growth of the account and this is referred to as "mountain area" when all the cubes of the mountain area are added up we get Mountain area = 86 The lake area is counted by adding up the area of the blue area using the right column to note the balance of the account Thus lake area = 20 The to get the lake ratio we simply do lake divided by mountain 20 / 86 Lake ratio = 0.2325 ( good ) For calculation purposes the extreme low of the equity curve is taken as the base level for measurment and the extreme peak of the mountain is taken as the high value to measure down from to get the depth of the water. This procedure runs on a bar by bar basis so it the highest peak that has occured "to date" if reading the data from left to right. Example No3 In the example below we can see the actual equity curve of a participant in the Trading IQ Game who achieved an excellent lake ratio of 0.020 which is lower and much better than those above. This metric is used by myself to help me select traders with strong promise and ability to produce good profits with low draw downs and short underwater periods. Lake ratio = 0.020 ( very very good ) Example No4 In the example below we can see the actual equity curve of a participant in the Trading IQ Game who achieved the dream and got a perfect lake ratio of 0.00 which simply means if you pour water on the equity curve ( mountain ) then it will not settle as their are no lakes for it to collect. This metric is used by myself to help me select traders with high ability to produce good profits with low draw downs and short underwater periods. Obviously there were only four trades to create this chart, and having months of trades without ever registering a losing trade is virtually impossible, but one can understand what fund managers look for when selecting traders to grow their trade accounts up. Lake ratio = 0.00 ( statistically improbable over a long time duration as it requires no losing trades ) The original lake ratio article by Ed Seykota is found here  ( Some distance down the page ) These pages below will also appeal to those who enjoy ratios, statistics and calculations. Price target computer ( Predicts exact maximum high and low ) Computing optimal risk  ( Same method as the Las Vegas card counter Ed Thorp ) 1987 crash calculator  ( Calculate your loss or profit if the 1987 crash happens again ) How to test a trading system ( Video simulation and maths ) Beginners guide to trading part one ( Six parts ) Hedging a portfolio with traded options View the Product guide for all platforms supported

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Precision Trading Systems was founded in 2006 providing high quality indicators and trading systems for a wide range of markets and levels of experience.

Supporting NinjaTrader, Tradestation and MultiCharts.

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