On one hand, you’re confused by the stock market or you don’t trust it. On the other hand, you know there is no other investment vehicle out there that will give you the kind of results the stock market does.
What do you do?
Well if it were me, I’d fire up my trusty computer and see if Google could help me find a trading system.
Unfortunately, there are more systems out there than Imelda Marcos has shoes. So you’re faced with, “How do I evaluate them all?” How do I get down and dirty and figure it all out?
First of all, you need to know what kind of trader you are. You need to assess how much risk you can handle, what kind of system is best for your account size, etc. But how do you crack open a strategy’s equity curve to find out what monsters are hiding under the bed?
How could you use the equity curve to focus in on the timeframes that would have made you say to yourself, “Ah geesh, this system is a dog,” if you were not paying attention?
Define Equity Curve
Frist of all, let’s define just what I mean when I say “Equity Curve.” This is how Investopedia defines it, “A graphical representation of the change in the value of a trading account over a time period.
“An equity curve with a consistently positive slope would generally indicate that the trading strategies of the account are profitable, while a negative slope would indicate that the account is in the red.”
Let’s start at the Very Beginning (A very good place to start)
Unless you want to contribute all your money to Mr. Market, if the equity curve is moving down, you’d say, “See Ya, wouldn’t wanna be Ya.”
If it’s flat, you’ll probably say the same thing. However, if it’s not heading to the basement. Or it’s not just sliding sideways like its having a jolly old time on a freshly polished floor but its slope has been making use of the stairs, you should take another look.
We’re going to use the Qit’s Ultra portfolio to examine what I’m prattling on about.
Here is an equity curve of QiT’s Ultra Portfolio. As you can see it’s slope is making very good use of the stairs – maybe even an escalator. If you stumbled upon this equity curve while doing your due diligence on trading systems, you would probably be quite interested in the strategy behind it.
However, what I am suggesting is this is only the beginning.
Once you find a strategy with an equity curve as impressive as this, you don’t stop there. You need to go to the tool shed, find the best shovel you have and start digging. You need to dig down then cut the equity curve into sections to get a closer look at the drawdowns.
Here is a chunk of the curve in 2015. This aggravating section from July 2015 to November 2015 was 5 months with no new high in the portfolio.
Once you start your snooping, you get a much clearer picture of just how hard it could be to stick to this system. You see how difficult this would be to live through if you’re not prepared for it. By the way, this portfolio made 46% CAR in 2015
In 2016 the Ultra had another “polished floor” period. This one from February 2016 to May 2016. Yet the strategy made 25% in 2016. As well, take a look at the incredible climb it took afterward.
Here is 2017. This period lasted from March until November with one little jolt of excitement in the middle. This was hard, no doubt about it.
Here is what the Ultra has done since last October. This is the reward for sticking with it.
Can you do this?
Before you start trading a system, you have to know if you can live with this.
You need to be aware of all the little nooks and crannies of your chosen trading system. The more you know about your system, the easier it will be to stick through the tough times.
Then, ultimately, profit from it.
As well, once you recognize your equity curve will only be making new highs approximately 10% of the time and will be in a drawdown 90% of the time, you’ll be able to live with these drawdowns with aplomb.
2017 was a year of hurricanes, wildfires, a nuclear threat from North Korea, and a #MeToo movement that toppled powerful men, yet the markets remained eerily calm. The VIX hit an all-time low, bottoming at 9.14 in November, dropping more than 17% overall in 2017.
Historically, low volatility precedes a market crash. Although what we saw in January and February could hardly be called a “crash” it was more of “I’m tired and need to take a rest.”
So what’s going on? Ask around, and you’ll find many opinions: We’re on the brink of another crisis; We’ve arrived at a new stock market normal; or there’s nothing to see here, volatility is consistent with historical patterns.
Let’s all remember
Remember the market tops of 2000 and 2007 were marked by a sudden acceleration in volatility and impulsive corrective moves exceeding 10% followed by rallies of the similar magnitude. The underlying theme of these subsequent rallies was a narrowing of leadership, negative divergences yet a renewed bullishness breathing a sigh of relief at precisely the wrong time.
This is exactly what we are witnessing now.
We’re the Plan in “Plan your Trade and Trade your Plan” – TraderJanie
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