Equity curve analysis: A fool’s path?

April 15, 2015 12:00 PM

Equity curve trading is simply a methodology where a trading strategy is turned on and off based on the gyrations of the equity curve. While there are many different approaches to employing equity curve trading, the concept is straightforward: trade strategies when they are making money, and temporarily turn them off when they are not. If only it were so simple.

With many of the basics of equity curve trading covered in the first installment, this article will look at two different methods of equity curve trading applied to three different real life trading strategies. Reviewing the results may allow some generalizations and conclusions about equity curve trading to be made.
Strategies scrutinized

Three unique, real world trading strategies will be examined with and without equity curve trading approaches. The streategies are the following:

Gold: Swing strategy based on daily bars trading during “pit” hours. 

E-mini S&P 500: Intraday strategy based on one-minute bars.

Japanese yen: Swing strategy based on 360-minute bars.

For each strategy, the most recent 450 trades will be studied, each of which trade only one contract per trade. This study represents three-to-nine years of trades, depending on the strategy. All trades are either from live trading or from out-of-sample walk-forward backtesting. No in-sample results are shown.

The closed trade equity curves for each of the strategies are shown in “Trading it straight” (below).

Evaluation process

Two different methods of equity curve trading will be examined in this study. The first method using a moving average of the equity curve as the criterion for turning the strategy on and off. When the “always on” equity is above the moving average line, the strategy will trade as normal. But, when the “always on” equity curve drops below the moving average, the strategy will be temporarily turned off until the equity curve again crosses above the moving average.

Different length moving averages will be examined. We will use 10-, 25- and 40-period moving averages.

The second method of equity curve trading will be using a new equity curve low as the cutoff criteria. In the same manner as the moving average approach, the strategy will be turned off when a new X trade, low in the equity curve, is reached, and turned on when the equity curve is above this value.

To keep consistency between the two approaches, the 10-, 25- and 40-period lows of the equity curve will be used here too.

These two filtering approaches are common in equity curve trading, but are by no means the only methods. Practically any indicator can be applied to an equity curve, in the same way these indicators can be applied to actual price data. This, of course, opens up a whole Pandora’s Box of possible approaches, with an infinite number of possibilities when indicator parameters are taken into consideration. Such a situation inevitably leads to over optimization and curve fitting, as the trader attempts to “tune” an equity curve trading approach to his particular equity curve.

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About the Author

Kevin J. Davey has been trading for more than 25 years. Kevin is the author of “Building Winning Algorithmic Trading Systems.”