Chuck LeBeau is a master trader and teacher who want ed to examine the quality of his exits, based on the belief that exits are far more important than entries in a trading system.
Since there were no existing measures available to use for his analysis he decided to invent his own, which he called the exit efficiency index.
The idea behind this concept is to examine the quality of your actual exit against the perfect exit in retrospect. He decided to look at all possible trades in approximately the same timeframe as the original trade. Comparing the perfect exit to the actual exit would allow the trader to determine if the system was in tune with the market when the trader is looking to exploit his edge.
Here’s how to do it. First, define the time period between entry and exit as the variable “t”. Now examine all price action within double that timeframe and call it “2t”. Find the highest possible price you could’ve sold at in the “2t” timeframe. In retrospect, that would be the perfect exit. Because we are creating an index of efficiency the scores will range between 1.0 for perfect and 0.0 for worst.
In order to develop the efficiency rating for each trade, divide the actual return by the perfect return and you will come out with a number between zero and one. Convert this to a percentage to see what percentage of the perfect return you actually received.
Based on Chuck’s analysis, a trading system that on average can extract 30 to 40% of the perfect trade is doing very well. This is important information for traders who are depressed about leaving too many profits on the table. Regret at missing profits is one of the most powerful psychological forces at work making you change your trading plan. Armed with this information, a trader can maintain the willpower and discipline to stick to good trading rules in the future.