Equity Curve Trading

Equity curve trading is an interesting strategy that not all spread traders know about, and its value is that it concentrates on the overall picture and not on individual results. Sometimes it can make a big difference, and at other times it may not be of use, but until you know about it you cannot find out for yourself whether your account could benefit from the strategy.

Firstly, the equity curve referred to is the value of your account over time, including open bets or trades. Hopefully it will be growing overall, but it can and will have drawdowns with the inevitable losses. However, when equity curve trading, quite often the strategy will be based on the balance curve rather than the equity curve. The balance curve is the amount in your account, which includes the closed trades, both profits and losses. Depending how many open positions you have at a time, there may not be much difference, so many people will choose the balance curve for simplicity.

Equity curve trading is based on looking at the moving average of the equity curve compared to the actual equity curve. If the equity curve is below the moving average, that means that recent trading has not been good, and one way of implementing equity curve trading is to cease live trading altogether when this happens. Others may prefer to reduce the size of bets placed. When the equity curve is above the moving average, then you can revert to trading live or the size of bets can be increased.

The reason for this is easily explained. If the equity is below its moving average, then trading is not going as well as you would hope, and therefore can be stopped until it improves. There can be various reasons for this. Perhaps the volatility of the financial security being traded has varied and that has affected the profitability of the strategy; you might be using a trending strategy, and the market has shifted into a range trading or “trendless” pattern, which would make your strategy underperform. Whatever has caused the trading to be less profitable, equity curve trading reduces the losses by stopping the rot.

Of course, even if you stop trading altogether, you should keep a log of the trades that your system would have required, and how this would affect the equity or balance curve. That way you can continue to monitor the system performance, and get back into the market when the equity curve rises above the moving average again.

It is important to run some tests on your equity curve trading methods, as not all stock picking strategies will benefit from it. Occasionally you will be trading a system that would have picked up after a drop, and recovered previous losses, and if you cease all trading then you will not benefit until the equity curve trading lets you back in again. So the system should not be adopted without doing some analysis. You may also want to investigate an alternative method of equity curve trading which restricts your trading when the angle of the moving average is pointing down or decreasing, and goes back to full trading when it is on the rise.