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A lot of books/articles/trading forums mention that "profit factor" is probably the most important measure and should be used to compare different trading strategies. They define profit factor as total gains/total loss. I can understand having a profit factor > 1 means the trading system is making money but I think you can't use this number for comparing trading strategies. Trading system with higher profit factor doesn't necessarily make more money than one with lower profit factor. For example if we have two trading strategies A and B as below,

Trading strategy A: Has a profit factor of 2

Trade 1: Buy XYZ @ 100 on Monday and sell it @ 150 on Tuesday making a profit of $50.

Trade 2: Buy ABC @ 100 on Wednesday and sell it @ 75 on Thursday for a loss of $25

Profit factor = $50/$25 = 2

Rate of return for this strategy = 25%

Trading strategy B: Has a profit factor of 3

Trade 1: Buy XYZ @ 100 on Monday and sell it @ 109 on Tuesday making a profit of $9.

Trade 2: Buy ABC @ 100 on Wednesday and sell it @ 97 on Thursday for a loss of $3

Profit factor = $9/$3 = 3

Rate of return for this strategy = 6%

Isn't the trading strategy "A" better than "B"? What am I missing here?

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  • $\begingroup$ Although I have seen this "profit factor" mentioned in trading blogs and trader discussion groups, it is never mentioned in textbooks or published papers etc. as far as I know. I agree with you that it seems intellectually dubious. Among other things it seems to mix together return and risk considerations. $\endgroup$ – noob2 Jan 31 at 0:45
  • $\begingroup$ Thanks. I am kind of new to trading and trying to build/test trading strategies as a hobby. I am trying figure out how to compare two different strategies. If you can recommend any book/articles that would be great! $\endgroup$ – user10697426 Jan 31 at 2:02
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    $\begingroup$ I think the point is that is does mix return and risk, and I also don't think its utility is made clear by considering an example of only two trades. Run a Monte Carlo analysis of a 2 PF strategy vs a 3 PF strategy, and you will see much shallower draw downs in the 3 PF strategy $\endgroup$ – Ian Ash Jan 31 at 11:05
  • $\begingroup$ The commonly accepted comparison metric in the industry is the Sharpe Ratio, which originated in academia. It has its drawbacks too, however. So I do not want to completely dismiss the Profit Ratio; amateurs make good contributions too in this field. $\endgroup$ – noob2 Feb 2 at 16:42

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