Scaling in, scaling out
We’ll demonstrate one approach on a trend-based system that will filter trades based on moving average analysis of the equity curve. After applying the basic system to one-hour euro charts for a period of six years, we get a sample of 1,950 trades. The equity curve goes through peaks and valleys as market volatility cycles affect the performance of the basic system. The basic system, without equity curve analysis, provides only $300 of profits for this period. Our results are based on a $10,000 account.
We’ll compare these results using an approach that administers positions based on a moving average filter of the equity curve. Normal trading takes place on crossovers above the moving average; no trading takes place on crossovers below the moving average. Our filter of the basic system is done by applying several moving averages to the raw equity curve. In the first chart in “Raw vs. filtered” (below), the basic system equity curve is shown in red, and a 21-period moving average of the equity curve is in blue.
The three filtered equity curves in “Raw vs. filtered” are generated by a system filtered using three different moving average lengths, as indicated: a five-period moving average, a 13-period moving average and a 34-period moving average. Clearly, the results of each are markedly different, but this was expected. The three different averages provide for different levels above the equity line for taking entries and exits.