Do the switch
As noted earlier, there are other ways to use equity curve analysis to improve trading systems. For example, instead of starting and stopping trading on crossovers of the equity curve, you can switch the system logic and trade the opposite on moving average crossovers.
Consider the trading results in “Switch hitter” (below). In this case, we applied a 10-period moving average to the equity curve for our basic euro system. The results are clearly impressive. They are based on fading the system — that is, going short when the system says to go long and vice versa — when the equity curve is below the moving average.
Normal trading takes place on signals that happen when the equity curve is above its moving average. Opposite trading takes place on signals that happen when the equity curve is below its moving average. As shown, this test produced a hypothetical equity curve with more profit and a lower drawdown. Profits increased from $300 to $35,000, using the same lot sizes and the same trading system signals on the same underlying instrument over the same period of time and without any additional money management rule.
Changing market conditions can be a window of opportunity rather than a source of trading system drawdowns. Sometimes the answers are beyond the trading system logic itself. Applying a different approach to trading, such as equity curve-based money management, can not only help minimize drawdowns, but it also can help maximize profits.
Octavio Riaño is a project manager at ww.digitaltradingsystems.com.