Of the many money management techniques out there, one of my favorites is to use equity curve feedback to guide position sizing. We did some blog posts in the past about how you could improve a real trading system using equity curve feedback. Most commonly, this technique is used to provide some sort of connection between the account equity (your position sizing) and the momentum.
Charting your own personal equity curve is very simple. Simply plot your account balances over history, with all positions marked-to-market, and you will have your own personal equity curve. This will tell you how the state of your account has been changing over time. This is very useful knowledge, but we can also consider a slightly different variant of this idea. Suppose we were to take a trading system and “chart” its equity curve (i.e. how well it has done) over a specified time period. We could get an idea of how well a strategy has done over time – not just the end result – but actually see the drawdowns and see when the big winners hit.
Although this may sound simple, this type of thinking has some interesting advantages. For example, within TradersStudio we can use equity curve feedback to switch to the best performing system. By taking a look at each system’s equity curve and performance we can pick the one that is doing well now. This helps increase robustness and doesn’t make your system dependent upon a specific set of parameters. Consider having two systems – the first is a simple channel breakout strategy and the second is an opening-range breakout system. Using the equity curve, we can dynamically switch between these systems depending on which one is doing better. We could, in effect, say “oh this system is in a slump so let’s abandon it and use this other system which is super hot”. That kind of robustness is key to trading success.
Other Equity Curve Ideas
Other ideas are to trade the equity curve in a more straightforward manner. Take the equity curve of a system and also calculate its moving average. Then you might code the system to stop trading when the curve crosses above or below the average, or instead of simply stopping trading altogether, you might simply reduce or increase your position size. A lot of how you implement this type of equity curve feedback is dependent upon what type of system you have. Suppose you developed a system that had a lot of little wins, but when it faced a drawdown it was ugly. Then halting all trading when the system seems to be performing poorly might improve profits. However, you might have another type of system – a so-called “revert to mean” system – that tends to win and lose with roughly the same frequency. In this case, a good strategy might be to increase or decrease position sizing. When the wins are looking like they’re “running out”, decrease sizing. When the losses look like they’re about to turn into winners, increase sizing. This can help turn what might not seem like a profitable system into a profitable one.
Equity curve feedback is an important tool in my own stock system development and design within TradersStudio Turbo. As chief systems designer for Tuttle Tactical Management, I often need to use this technique in my own systems development. I would encourage you to check out TradersStudio Turbo as it can do all of these equity curve techniques listed.