The attractiveness of the recovery factor is that it is an indicator that allows combining different criteria to evaluate the attractiveness of a strategy, such as profitability and possible drawdowns. Its calculation indicates how many times the current profitability of a strategy is greater than its historical maximum drawdown. As already stated, it shows how quickly a system can return to profitability after drawdowns. The recovery factor is an important indicator of the reliability of a trading system and should be carefully studied by the trader when evaluating different strategies. Why is the recovery factor important in trading? However, at the moment, on all major Internet sites, the recovery factor, including its application to PAMM accounts, is calculated in the first way. The recovery factor value calculated in the second way provides a truly objective assessment of the stability/reliability of a trading system. Recovery Factor = Net Profit/Total Drawdown For the level of risk you take, the first strategy produces a higher profit and has a better chance of recovering when a drawdown occurs. Based on this metric, we can say that this strategy is quite a bit better than another one that produces a profit of 120,000 with a maximum drawdown of 30,000 (profit factor of 4:1).Īlthough the second strategy generates more profit, it does so with a higher level of risk. This means that the recovery factor is 8:1 (100,000/12,500), which is a very favorable value. Recovery Factor = Net Profit/Maximum Drawdownįor example, suppose a trading strategy makes a net profit of $100,000 with a maximum drawdown of $12,500. The traditional (classical) method for calculating the recovery factor is expressed by a simple formula, as the ratio of net profit to maximum drawdown: The recovery factor can be calculated in two different ways that give two different results. How is the profit factor of a strategy calculated? In part, the recovery factor indicates the ability of a strategy to recover after a period of losses (drawdown) together with the reserves for the resumption of trades after drawdowns. This indicator gives the trader an idea of the extent to which the total profit of the strategy exceeds the level or depth of the maximum drawdown. The recovery factor is usually measured in points or percentages. The recovery factor is an important indicator of the health of a trading system, which is calculated as the ratio of absolute profit to maximum drawdown.
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