Equity curve trading
by Michael R. Bryant
A money management technique that can sometimes improve trading performance is to modify the position sizing based on crossovers of a moving average of the equity curve. The basic idea is to either trade more or fewer contracts when the equity curve crosses above or below its moving average.
There are at least two basic ways to implement this idea. One is to stop trading when the equity curve crosses above or below its moving average and to resume trading on a crossover in the opposite direction. This is the most basic and commonly used method. You would typically stop trading when the equity curve crosses below the moving average if your system or method tends to produce streaks of wins and losses, so that when it starts to lose, it's best to stop trading until it starts winning again.
On the other hand, if your system or
method tends to "revert to the mean" -- after several wins, it starts to
lose, and vice-versa -- you would typically stop trading after the
equity crosses above the moving average.
Dependency analysis can be used to determine if
your system has either of these tendencies with statistical
To illustrate, consider the trading results shown below. The equity curve is shown in red with a 10 period moving average in green. The bar chart below the equity curve displays the number of contracts, which is determined by taking one contract for every $3000 of equity.
equity curve and number of contracts prior to applying equity curve
crossover rule. The equity curve is shown in red; a 10 period moving
average of the equity curve is in green.
Equity curve and number of contracts with equity curve crossover rule applied. Trading is stopped on crossovers above the moving average; trading resumes on crossovers below the moving average. The equity curve is shown in red; a 10 period moving average of the equity curve is in green.
Not only does this change produce a gradually rising equity curve with more profit and a lower drawdown, but it does so with fewer trades. The blank areas in the bar chart below the equity curve indicates the trades that are skipped. The number of contracts for the trades that are taken tends to increase much more smoothly than before, without the dramatic rises and drops of the original curve.
A similar but more subtle effect could be achieved by increasing and/or decreasing the position size relative to the value determined from the dollar equity amount per contract ($3000 in the example) on crossovers of the moving average.
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