Equity Curve Trading For Enhanced Profitability and Reduced Risk

In my trading practice I am always looking for better ways to robustly manage risk, but complicated strategies for this do not get me excited.  The more complicated, the more likely it will breakdown in the future.  It is the sophisticatedly simple, elegant and easily repeatable trading and risk management practices that tend to attract me.  I have come to believe trading your own equity curve as a level of risk management fits this description.

To determine if my hunch on this had merit, it had to be tested.  Because I have run a particular short-term trading system as a little side test for several years (now being implemented as a new trading operation), I have a decent amount of data to use for further testing and tinkering.  Every trade over the period of the multi-year experiment has been recorded down to the number of times stops were systematically moved by their algorithm.  Therefore, I was able to go back, find one of the most challenging 12 month periods in the test, and see what would happen if I traded the equity curve for that period.  By retesting this data with no changes other than the risk profile per trade, the behavior we are trying to analyze is isolated.   

Lets define terms.  By equity curve, I am talking about the equity of the account as it moves through time.  Very similar to prices of stock and commodities on a time and price based chart.  The equity curve is either going down, sideways, or up.  There are no other options. 

By trading the equity curve, I am talking about taking cues from what just happened to the equity curve in order to make a future decision on how much risk to use on the next trade.  The opposite of trading the equity curve would be to keep risk at a static proportion to equity no matter what has recently happened in the trading operation.  

I already had a static proportional risk profile as a baseline.  The prior test had been run risking 5% of equity on every single trade signal.  Now all that had to be done was to rerun the trades with an adaptive proportional risk profile.  

Here is what I did:  The first losing trade in a series resulted in proportional risk being reduced from 5% of current equity to 2% of current equity.  The first winning trade in a series resulted in proportional risk being increased from 2% of current equity to 5% of current equity.  Like I said this is simple.  I don't like overly complex.   

The premise was that a system based on technical price trending rules or heuristics will undergo periods that are better suited for the system to be profitable as well as periods that are not so well suited for profit.  When a losing trade occurs, it is a signal that a drawdown period may be at hand.  When a wining trade occurs, it is a signal that a profitable period might be afoot.  These signals in the equity curve's trend tell us when it is best to increase or decrease risk exposure.  

Again, this data is from a short term system.  The average month in this twelve month period saw sixteen round trip trades.  Therefore, there are ample realized gains and losses in the data.  The equity curves you are about to see only represent realized gains and loses (closed trades).  Although not really a direct factor in what we are measuring here, it should be noted that commissions were accounted for in each trade.

Here is a chart of the two trade by trade equity curves -adaptive and static: 

The adaptive proportional risk profile was 69% more profitable in the end than was the static proportional risk profile. 

It is clear that equity curve trading worked in this example.  I speculate that it is robust and will work over other long periods of time as well.  In fact, I will probably try to find time to continue testing this on various periods of data just to see.  In fact, it makes me wonder if the gap between the static risk model and the adaptive risk model would continue to widen exponentially in the future.  Perhaps it is time for me to learn EasyLanguage and try to find more automated ways to test these things.  

It is my current plan to  implement equity curve trading into the new short term operations I have recently embarked on.  

Does anyone else out there have any experience with this?  If so, I would love to hear from you.

Budget Puzzle at New York Times

You can try to fix the nation's budget deficit at the New York Times via their Budget Puzzle.  They have defined certain parameters and areas for you to work within, so nothing too radical is allowed by the puzzle, but it is still fun. 

I tried it and was able to close the 2030 projected budget shortfall, and come within a hair of closing the 2015 budget short fall without raising taxes.   

Here is what I did within the parameters allowed:


1) Cut Foreign aid in half.  This is all the parameters would allow for.  I would eliminate all foreign aid if it was up to me.  Charity should be up to individuals to provide as they see fit.  Besides, once the funds for aid are extracted by compulsion, it is no longer charity.  Also, because of the fact that aid has to go through bureaucracy on the receiving end, foreign aid is typically no more than taking the money from the poor of one country and giving it to the rich of another.

2) Eliminate earmarks.  

3) Eliminate farm subsidies.  Yes!  Let the markets direct farmers, not government central planning from the FDR era.   


4) Cut pay of civilian federal workers by 5%.  That's all the puzzle would allow.  I would cut it by more.  


5) Cut 250,000 government contractors. 


6) Other cuts to the federal government.  Yes!  Eliminate entire agencies.  


7) Cut aid to states by  5 percent.  Again, all the puzzle would allow.


8) Reduce nuclear arsenal and space spending.  Let's face it folks; we can not currently afford this.  


9) Reduce military to pre-Iraq War size and further reduce troops in Asia and Europe.  I suggested this at a town hall meeting with Senator Bob Corker the other night, in what could be described as a cat call from the audience (we were invited by the host to do such things), and I was called a radical by the lady next to me.  Corker did not seem to like the idea either.  The bottom line is that we just cannot afford to continue trying to be the policemen of the world. 


10) Reduce Navy and Air Force fleets.  Again, we cannot afford, nor is it morally justified, to try and be the policemen of the world.   


11) Cancel or delay some weapons programs.  If we are not going around seeking monsters to destroy, we will not need these as much as it might be perceived that we need them now.  If we keep running a deficit, we will not be able to fight future wars of defense should they arise.   I know some of you won't like this, but would you rather have the funds to fly the equipment we have (best in the world) if we are attacked, or would you rather have the latest and greatest and no resources to fly it with?  Don't answer that, I've seen what is parked in some of your garages and purchased with debt (your future labor). 


12) Reduce noncombat military compensation and overhead.  Again, we just can't afford what we are doing, and we are already taxed pretty heavily, when all the multiple levels of taxation are added up.


13) Reduce the number of troops in Iraq and Afghanistan to 30,000 by 2013.  This was the option given in the puzzle.  I would prefer to save even more by ending those foolish quagmires. War was never even declared after all.   When did it become "conservative" to get burried in debt for the purpose of enriching the military industrial complex?


14) Increase the Medicare eligibility age to 70.  This is what happens when a society starts depending on government for its needs and wants -the government runs out of money.  Medicare should have never been a program in the first place.  Lets work towards ending it by allowing younger generations to opt out of both paying for it and participating in it. 


15) Cap Medicare growth starting in 2013.  Sure, I will attack the entitlement programs by anyway the puzzle lets me.  Help should not be provided at the point of a gun or coercion by government.  Private charity and free-markets are better and more moral alternatives. 


16) Raise the Social Security retirement age to 70.  Here again, I want to eliminate this whole program.  Let younger generations opt out.  It is a bankrupt system that, if run in the private marketplace the way it is currently run by government, would lead to its directors being put in jail like Bernie Madoff.  


17) Tighten eligibility for disability.  Individuals should provide for their own insurance through savings and purchasing insurance on an open and free market.  The next line of defense should be family and charity.  These government programs cannot last, and that is why the government has a deficit.  


The rest of the choices were various options to raise or create new taxes.  As I mentioned at the outset, I did not choose any of them when trying to solve the puzzle.  Think about this when you are going through the puzzle yourself:  If you need or want something, is it morally legitimate for you to go over to your neighbors' homes armed and demand they give you what you need or want?  Of course it is not.  If it is not morally legitimate for you to personally do it, then it is not legitimate for you to hire a third party or government to do it.  But that is exactly what people do when they ask government to give them some positive benefit -they are asking this third party, to tax that benefit out of others without consent of the others.  If the others don't pay, then the guns and jail cells come into play.  Government is force.  Stop using it against each other. 

EURO Update 11/15/10

Back on 11/3/10, I posted a chart of the EURO and some comments suggesting a short selling opportunity was approaching.  Since that time, the EURO has broken a trigger level mentioned in that post.  

Because much of my assertive trading effort is spent on short term e-mini S&P futures trading (not covered at this blog), I am patiently waiting and watching how this develops from here.  I will be looking to put on an intermediate or longer term short position via either futures or ETFs.  I'll be watching some charts that are shorter term than the weekly chart above to see what the price action might be saying about a possible emerging downtrend, and I will post what I find.

BTW, our friends over at EWI have a free week going on right now for their highly acclaimed FX analysis services.  It seems they are on the same page as we are here, or it might be more appropriate to give respect where respect is due and say I am on the same page as them.  They are definitely the leaders in Elliott Wave and Technical Analysis based market forecasting.  EWI's various services are were I learned to do a lot of what I do.  Check out their free week by CLICKING HERE.

They will no doubt be following the long, intermediate, and short term in the EURO and other FX markets on an intraday basis FOR FREE until Thursday this week.  Check it out.

Federal Reserve Protest Song, by Skeet Childress

EWI's FOREX FreeWeek is now on: Get charts, analysis and forecasts for the Dollar, Euro, Yen and more

Our friends at Elliott Wave International have just announced the beginning of their popular FreeWeek event, where they throw open the doors for you to test-drive some of their most popular premium services -- at ZERO cost to you.

You can access all the intraday, daily, weekly and monthly forecasts from EWI's Currency Specialty Service right now through noon Eastern time Thursday, Nov. 18. This service is valued at $494/month, but you can get it free for one week only!

It's an exciting time in the Forex world. Since the high in early November, the Euro has declined sharply against the U.S. Dollar. Does this mean that a top is in place? Find out during EWI's Forex FreeWeek -- on right now! 

Learn more and get instant access to EWI's FreeWeek of FOREX analysis and forecasts now -- before the opportunity ends for good..

Moving Stops On Gold

We have moved our stop orders in intermediate term gold positions up to 1364.19.

S&P 500 Buys a Little More Time

 (charts can be expanded by clicking on them)

This week the S&P 500 broke above the high it had posted in late April, taking us to what had been our alternate count.  You can see the updated Elliott Wave labels above.  Bottom line: you have a little more time, but not much, to get your house in order. 

Some coincidental readings to notice on the weekly chart above are: RSI (14) is in the range of up-trending action as defined by Connie Brown's book "Technical Analysis for the Trading Professional".  Rate of Change is still negatively diverging, but has actually broken above a downtrend line drawn across some of its previous tops.  The simple, but effective, trend following methodology of following the directional signals of a fast moving average as it is above (buy) or below a slower moving average (sell) also has been confirming this uptrend for several weeks now.

Some things to worry about if you take the long side here: Whenever wave 4 of (C) of [2] gets going, it will probably be an ugly churning mess.  If you go long here, and I might, you need to have very loosely set stops for now.  That is until we can see the still yet to begin wave 4 terminates and wave 5 begins, allowing us to tighten stops and look for an exit (and reverse) in wave 5.  


I do not currently have a great read on the internal wave-3 Elliott count.  In the past, this has sometimes lead to the pattern extending and providing more subdivisions that all of the sudden make for a great count.  Then again, wave-3 could possibly be near its own termination point.  I just don't have that amount of detail pegged down yet -just being honest.  

Any longs should have a loose stop no lower than the wave-2 of (C) of [2] low on the chart above.  That level in the cash index is: 1039.70.

On the daily chart we also see that RSI (14) is in that uptrending range as discussed in Connie's book.  That's something for us to continue to monitor.  Rate Of Change (ROC) on the daily is still negatively diverging -not a big confidence builder for longs right here. 

Possible EURO trade setup 11/03/10

Assertive traders could sell the EURO (or use inverse ETFs) short with a break below 1.3726 against an initial buy to cover stop at 1.5151.  If the position is triggered, and there is enough follow through to confirm a turning point, then the stop can be moved down to that turning point.

Others who want to wait at see more action to the downside before making a commitment, could simply look for the last upwards trendline on the chart above to be penetrated and closed below.

Gold is setting up for a trading oportunity

In speaking with a long time friend, who also happens to be an independent trader, on the phone today, I said "have you seen the gold chart?".  He replied quickly, with a "yes!" and followed with a rapid description of what appear to be clear Elliott Wave patterns in the chart above.  I was stoked, because I've been looking at it in the same way.  

I left the Elliott count out of the chart above for fun.  Those inclined, give it a shot and post below or send me an e-mail and I will tell you the count my buddy and I spoke about. 

Although Elliott gives me a bias on which way I think this thing is going to go in the intermediate term future, there are basic breakout setups as well.  Should gold break below 1318.80, a downtrend that could be ridden on the short side would be indicated.  Should gold break above 1386.50, an uptrend that could be ridden on the long side would be indicated.  

However, if you are like my friend and I, you might already have a bias towards one of these breakout scenarios.  That would mean you could put the trade on now, reducing your risk against the stop, which should be either the 1386.50 or 1318.80 levels, depending on your outlook.  What do you guys think about gold?  Which way is it going to breakout out of the range between 1386.50 and 1318.80?

"Market Manipulation" Is Not Why Most Traders Lose

A look at EWI president Robert Prechter's requirements for successful trading November 2, 2010 

By Elliott Wave International

How often have you heard analysts refer to a down day on Wall Street as "traders taking profits"? Sounds great, but the sobering fact is that most traders -- in futures, commodities, or forex -- lose money.

Any book on trading will list for you the many reasons why most traders lose. Yet some traders do win; some even set records. In 1984, Elliott Wave International's founder and president Robert Prechter won the U.S. Trading Championship, setting a new all-time profit record of 444.4% in a monitored real-money options account. Later in his monthly Elliott Wave Theorist, Prechter published a Special Report "What A Trader Really Needs To Be Successful" with 5 important insights for would-be market speculators (including the explanation of why "market manipulation" is not why most traders lose.)

Here's a quick excerpt -- and to read Prechter's Special Report in full, free, look below.

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"What A Trader Really Needs To Be Successful" (excerpt)
By Robert Prechter

Ever since winning the United States Trading Championship in 1984 (see footnotes, p.4), subscribers have asked for a list of "tips" on trading, or even a play-by-play of the approximately 200 short term trades I made while following hourly market data over a four month period. Neither of these would do anyone any good. What successful trading requires is both more and less than most people think.

In watching the reports of each new Championship over the past three years, it has been a joy to see what a large percentage of the top winners have been Elliott Wave Theorist subscribers and telephone consultation customers. (In fact, in the latest "standings" report from the USTC, of the top three producers in each of four categories, half are EWT subscribers!) However, while good traders may want the input from EWT, not all EWT subscribers are good traders. Obviously the winners know something the losers don't. What is it? What are the guidelines you really need to meet in order to trade the markets successfully?

When I first began trading, I did what many others who start out in the markets do: I developed a list of trading rules. The list was created piecemeal, with each new rule added, usually, following the conclusion of an unsuccessful trade. I continually asked myself, what would I do differently next time to make sure that this mistake would not recur? The resulting list of "do's" and "don'ts" ultimately comprised about 16 statements. Approximately six months following the completion of my carved-in-stone list of trading rules, I balled up the paper and threw it in the trash.

What was the problem with my list, a list typical of so many novices who think they are learning something? After several months of attempting to apply the "rules," it became clear that I made not merely a mistake here and there in the list, but a fundamental error in compiling the list in the first place. The error was in taking aim at the last trade each time, as if the next trading situation would present a similar problem. By the time 16 rules are created, all situations are covered and the trader is back to square one.

Let me give you an example of the ironies that result from the typical method of generating a list of trading rules. One of the most popular trading maxims is, "You can't go broke taking a profit." (The brokers invented that one, of course, which is one reason that new traders always hear of it!) This trading maxim appears to make wonderful sense, but only when viewed in the context of a recent trade with a specific outcome. When you have entered a trade at a good price, watched it go your way for a while, then watched it go against you and turn into a loss, the maxim sounds like a pronouncement of divine wisdom. What you are really saying, however, is that in the context of the last trade "I should have sold when I had a small profit."

Now let's see what happens on the next trade. You enter a trade, and after just a few days of watching it go your way, you sell out, only to stare in amazement as it continues to go in the direction you had expected, racking up paper gains of several hundred percent. You ask a more experienced trader what your error was, and he advises you sagely while peering over his glasses, "Remember this forever: Cut losses short; let profits run." So you reach for your list of trading rules and write this maxim, which means only, of course "I should NOT have sold when I had a small profit."

So trading rules #2 and #14 are in direct conflict. Is this an isolated incident? What about rule #3, which reads, "Stay cool; never let emotions rule your trading," and #8, which reads, "If a trade is obviously going against you, get out of the way before it turns into a disaster." Stripped of their fancy attire, #3 says, "Don't panic during trading" and #8 says, "Go ahead and panic!" Such formulations are, in the final analysis, utterly useless.

What I finally desired to create was a description not of each of the trees, but of the forest. After several years of trading, I came up with -- guess what -- another list! But this is not a list of "trading rules"; it's a list of requirements for successful trading. Most worthwhile truths are simple, and this list contains only five items. ...

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Read the rest of Prechter's report now, free! Here's what you'll learn:

• Why a trading method is a "must" for your success
• What part discipline plays in your trading success
• Why "market manipulation" is not why most traders lose
• How to gain trading experience
• More

This article was syndicated by Elliott Wave International and was originally published under the headline "Market Manipulation" Is Not Why Most Traders Lose. EWI is the world's largest market forecasting firm. Its staff of full-time analysts led by Chartered Market Technician Robert Prechter provides 24-hour-a-day market analysis to institutional and private investors around the world.