The Misleading Nature of Equity Curves

Filed under: Learn Forex Trading |

Keeping a record of the equity curve of your trading bank is important for a number of reasons. Perhaps the most important of these reasons is to always know what your maximum drawdown is. If your maximum drawdown is greater than 30% of your bank, then you should probably re-adjust your risk levels. You also need to know that your equity chart is moving up from left to right, but this is where things can get a little bit misleading. Let me show you a couple of graphs of equity curves to highlight my point.

 

Figure 1.

Figure 1 shows my equity chart for this year (January 1st to the present). I’m sure you’ll agree that it makes pretty dire reading – down by 10% and the chart visibly moving down from left to right. If you had just started a new trading system, you would probably give up at this point and conclude that the system is flawed.

 

Figure 2.

Now take a look at Figure 2. This time, the chart is moving up from left to right and there are profits of around 30%. I’m sure you would think that this trading system has a good edge, and that if this were you, you would continue with the trading system, as it seems to be very profitable.

 

However, what I have not told you yet is that this (Figure 2) is my equity curve from July 2011 to the present, and that the data from Figure 1 is contained in the right hand side of the chart in Figure 2. This demonstrates that you really need a good sample of data before you can come to any firm conclusions about a trading system. A few hundred trades are best as a minimum, but more would be even better. For the purpose of testing a system, I would not make any conclusions at all before one hundred trades have been made.

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