Equity Curve Rules, Trade Smaller When You're Out of Sync

[Fairman]

Equity Curve Rules, Trade Smaller When You're Out of Sync

Your equity curve, the line showing your account balance over time, can be more than a record. Some traders use it as a feedback tool to adjust risk.

The idea: when your results are trending down, your trading may be out of sync with the market or with your own discipline. Reducing risk during those periods protects you. When the curve recovers, you return to normal size.

A simple rule set:

1. Choose a reference. For example, a 10-trade or 20-trade moving average of your equity.

2. If your equity is above the average, trade normal size.

3. If your equity is below the average, cut risk by half, or trade only A+ setups.

4. When equity moves back above the average, return to normal risk.

Alternative approach based on drawdown:

- Down 5% from peak: reduce risk by 25%
- Down 10%: reduce risk by 50%
- Down 15%: stop trading and review

Benefits:

- Limits drawdown depth
- Encourages reflection when things go wrong
- Reduces emotional pressure

Drawbacks:

- You may trade small during a recovery
- Rules can be arbitrary without testing

Test such rules in your journal data before using them. Ask: would this have improved my results and calmed my nerves?

A good risk plan responds to reality, not to hope.

[Fairman]

One way to make this concrete: plot a 20-trade moving average of your equity curve. When the actual curve sits under that average, cut risk in half. When it climbs back above, go back to normal size. It's crude, but it stops you from pressing full size through a cold patch.

[LondonNewsTrader]

Rules can be arbitrary without testing

Testing these is easier than it sounds if the journal has R values per trade. Replay the trade list with the rule applied, halving R whenever equity is below its 20-trade average, and compare the final total and the deepest drawdown with the original. For many strategies the drawdown shrinks noticeably while the total barely changes, which is a decent trade-off. For others the rule cuts size right before the recovery and leaves you worse off.

One thing I'd check alongside it is what caused the dips. If most of them came from a few weeks of heavy central bank news, reducing size on those weeks might do the same job more directly than reacting to the curve after the damage is done.

[Fairman]

A caveat I didn't mention: equity curve rules can lag. By the time the curve drops below its average, part of the bad run has already happened. It still helps, just don't expect it to catch the start of a drawdown, it limits the middle and end of it. The length of the average matters. A 20 trade average reacts faster but switches risk up and down a lot. A 50 trade average is smoother but slower. I'd test both on your own trade history before choosing. Also decide in advance how you return to full risk, otherwise the rule can keep you small for months.

[Shadow Trader]

Replaying the rule on a made up trade list shows both sides of it at once. Say 60 trades, 31 winners at 1.5R and 29 losers at 1R, with a cold patch in the middle and equity compared with its own 20 trade average.

In the made up chart below, full size finishes at 17.5R with a deepest drawdown of 8R, while the halving rule finishes at 16.5R with a drawdown of 5.75R. So 1R of profit buys back 2.25R of drawdown, which most people would happily take.

img_12782_r1.png (99.69 KiB) Viewed 35 times

The cost sits right after the low. The rule cuts size on 18 trades, and six of those come after the last loser of the cold patch, because the average is still being dragged down by the losses.

That lag is easier to trim through the exit condition than through the length of the average. One option worth testing is a return to full size after two straight winners at half size, which here would have come a few trades sooner.

The 5, 10 and 15 percent tiers in the opening post have the advantage of not flipping back and forth around a line. Has anyone run both versions on the same trade list to see which one whipsaws less?

[FXS Prop Desk]

Equity curve rules can help, but the challenge is choosing the trigger. A common version uses a moving average of the equity curve, for example 20 trades. Trading at half size when the curve is below its average reduces losses in bad periods.

The downside is that it also reduces gains at the start of a recovery, since size only returns to normal after the curve crosses back above its average. Testing it on past results before using it live shows whether the trade-off is worth it.

[Shadow Trader]

The point above about smaller gains at the start of a recovery shows up most clearly with the drawdown tiers from the opening post. Half size does not just shave the rebound, it roughly doubles how long the rebound takes.

Say the account is 10 percent below its peak and the rule has cut risk from 1 percent to 0.5 percent. The way back to the peak is an 11.1 percent gain, because 0.1 divided by 0.9 is 0.111.

With an expectancy of 0.2R a trade, full size earns about 0.2 percent per trade and half size about 0.1. Ignoring compounding, that is roughly 56 trades to recover at full size and 111 at half.

At three trades a day that is the difference between about four weeks and seven or eight weeks of recovery. That stretch is long enough for doubt about the system to creep in, which is exactly what the rule was meant to prevent.

One middle path is to step back up in stages, so 0.5 percent until the account is within 5 percent of the peak, then 0.75, then full size. Has anyone compared a staged return like that against the all at once version on the same trades?