Intercambios, conflictos y alianzas hispano-pehuenches

Here is a subject with almost as many possibilities as there are beliefs on how it works. Trading the average of the equity curve can assume many shapes and forms. The idea of this method is to take the equity point of the previous 10 days, add them together and divide by 10 (or by any other arbitrary number). This is the average of the equity curve. As a general rule, when the equity is moving up, the average will be under the actual equity. If the equity curve is moving down, the aver- age will normally be above the equity. Therefore, the trader relying on this system only takes trades when the equity curve is above the aver- age of the equity curve and then stops taking trades when the equity moves below that average. Even though no trades are being taken, the trader continues to plot the equity curve and when it moves back above the moving average, the trader resumes taking trades.

This is the most popular use of trading an average of an equity curve. This chapter deals with this method and many more possible methods. It also examines the validity of the method, how it should or should not be used and then offers some other ways to implement the methods.

First, the question must be answered, is trading a moving average of the equity curve a type of money management as defined in this book? Trading an average of the equity curve does not address the

158 OTHER PROFIT PROTECTING MEASURES TRADING THE AVERAGE OF THE EQUITY CURVE size of the investment being made, which is included in that definition.

It addresses whether the next trade should be taken or not. This is a form of trade selection. Trade selection has no mathematical substance to prove the effectiveness, or for that matter, disprove the effectiveness of the method. Therefore, it cannot be viewed as a true form of money management. And, if not money management, then what. I would clas- sify this method as a form of risk management. The two are not the same. Risk management simply takes steps to attempt to curb risk ex- posure. Risk management is a safety step. It is an extra step traders can take in addition to money management.

As stated previously, trading the average of an equity curve sim- ply means that if the equity is above the average of the equity curve, trades will be taken. If the equity is below the average equity curve, trades will not be taken. The single purpose in attempting to apply a strategy such as this to trading or investing is to minimize risks. At no time should this method be seen as a profit-enhancing method. This does not mean that it cannot or will not enhance profits; at times, it very well may. This is a side benefit if it happens. Equity curve trading attempts to remove a trader from the risk of large drawdowns, while placing the trader in a position to benefit when the method or system begins to draw back up.

Trading is about one thing: Risk versus reward. There are trade- offs. A trader risks X dollars to make Y dollars. Before taking the trade, the trader must believe the potential reward is worth the risk. Equity curve trading does exactly the opposite. The risk is the dollars that potentially will not be made while the reward is potentially the dollars that will not be lost. The trader must believe that it is worth risking potential gains to protect existing capital.

To apply average equity curve trading to your account, you must take the X day average of that equity curve and plot it on the same chart as the actual equity curve itself. Figure 11.1 shows an equity curve of a hypothetical track record produced from a system I devel- oped. The actual equity curve is the bold line while the equity curve average is the thinner line that is below the equity curve about 80 per- cent of the time. The graph below is the equity curve that is produced from taking out the trades immediately following a drop below the av- erage equity curve.

In this example, there are 132 trades without trading according to the average equity curve; 47 percent of these trades were prof- itable yielding over $61,000 in profits with a largest of $7,625. After applying a g-point moving average of the equity curve

Figure 11.1 The curve that results from taking outthetrades immediately following a drop below the average equity curve.

and taking only trades above the moving average, the net profit dwindled down to $39,500 and 105 trades. The winning per- centage remained relatively the same but the was actu- ally over $8,400 . . . more than without trading the average equity curve!

But, before you completely throw in the hat on this method, there was a reason I gave this example. This is one system applied to one market. This is about the worst performance drop you should see on any single system and market. The moving average that was chosen was picked completely out of the blue. There was no opti- mization whatsoever to this example. I chose it to show that there are risks in trading this method. The risks are not necessarily in what you could lose, but in what you might not make. You will also notice that the method is currently in a and trades are not being taken. If we were to extend this drawdown, you would see that you are protecting the account from two things that seem to happen when they are least expected. The first thing the account is protected from is complete and total system failure. If the system suffers complete failure, the account will not be partaking in most of the trades that make up that failure. I know of one particular system traded by many clients that would have benefited greatly this year from avoiding a massive drawdown. This would have also protected peace of mind.

160 OTHER PROFIT PROTECTING MEASURES ANALYZING THE AVERAGE EQUITY CURVE 161 The number one reason for business failure is undercapitaliza-

tion. I would also deem that it is the number one cause of trading failure. Trades are undercapitalized to withstand the large downs that occur with the leveraged trading arena. They may have the capital to withstand it, but the don’t have the risk capital to withstand it. By taking the risk for the extended drawdowns away from the account, the capital should have a much longer life span.