Equity curve: Trading capital management strategy

Equity curve: Trading capital management strategy

Mar 24 • Forex Trading Articles • 460 Views • Comments Off on Equity curve: Trading capital management strategy

Equity curve trading, that is, trading on the equity curve, is a rather specific method of protecting your deposit from the consequences of an excessive drawdown. Usually, novice traders spend most of their time looking for a suitable trading strategy or plan, as if not realizing that every trading strategy will have the best and worst periods in the market. Traders who study price charts often forget that a graph of the equity curve (that is, the curve of the change in the balance of your trading account) will tell you much more than the results of individual trades.

The theory is simple. Everyone has probably heard the advice: “when things go wrong in the market, reduce your position size or even take a break and stay out of the market.” The advice is the most correct, but not very specific.

How do you determine which period is the worst for your strategy? How do you know when this bad period will end? And then what to do? The equity curve strategy will help answer all these questions.

How to determine the worst period for a strategy?

The method consists of observing your capital curve, which can be obtained from your trading platform, for example, Metatrader, in the so-called statement (report). You can connect a trading account at myfxbook. The study of the capital curve is necessary to protect against excessive losses, especially a series of losses, that is, the worst periods for balancing the trading account.

The easiest way to keep track of changes in the balance of a trading account is to regularly copy Excel data. For example, enter the current balance of your deposit every day after a trading session. Next, we impose a moving average on the resulting trading capital curve. Excel has a function to add a moving average to such a chart.

Objective rule of return to normal trading

As long as our equity curve remains below the moving average, we stand aside and only observe the market, adding the account balance value to Excel after each trading session (as described in paragraph 1). As the market becomes more in sync with our strategy again, the equity curve will rise. Crossing below the average is a signal that the market is becoming favorable for our strategy again, and we can return to normal trading on a real account. Below is the same dataset, except that we ignore the worst periods of capital downturns when using this method.

The Bottomline

Of course, there are drawbacks to this approach, as to any other. You will have moments when you stop trading on the eve of your biggest profits, and vice versa, return to real trading, and the strategy will start to lose again. However, this method gives you an added advantage as we only trade when the market is most consistent with our strategy. The main advantage is also the smoothing of the equity curve and, above all, smaller drawdowns. This, in turn, allows for a slight increase in position size, but this is unnecessary. Thanks to the method, the risk of draining the deposit are sharply reduced.

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