Thursday, August 9, 2012

The hard road to consistency VI - Your equity curve as a price chart.

If you plot your winning days as green bars and losing days as red bars, you get a chart of your account size that looks similar to the price chart such as the one shown above. What makes a price chart go up and down also makes your trading account balance go up and down. When your trading is in an uptrend, you have mostly winning days with occasional losing days. The fewer and smaller your losing days, the faster your account grows.

Therefore a winning trader's account shows a cumulative graph like that of b1-17. A breakeven trader is likely to have alternating winning and losing days, todays gains lost the next day such as the range between b45-59. A losing trader is likely to lose a few times (b18-25) and go on tilt (b26-29) and then stop trading or change his style.

Its obvious that for your account to grow, you need to have fewer and smaller losing days and larger and greater number of winning days. While you may not be able to control the number of winning days versus losing days in the beginning, you certainly have the power to control how large a losing day is. Limiting your maximum loss per day prevents days where you go on tilt, effectively reducing days that look like b27 to a small bear bar, meaning much faster recovery on days where price action is more suited to your style and skill level of trading.

The first thing a big losing trader needs to do is be a smaller losing trader and then change to a breakeven trader. If you take trades where your wins are twice as large as your losses, there are very few ways you can be a losing trader, for example by going on tilt and taking questionable trades. At worst you should be a breakeven trader with alternating winning and losing days.

Once you are a breakeven trader, you can stay in the game indefinitely and hone your trading skills until you slowly start seeing profit. A breakeven trader can keep detailed logs regarding setups tried, stop sizes used, win rates, confidence in the read, etc. and narrow choices to a small set of setups that work for him. Continuous focus on this small set of setups over time will slowly flip these setups from net breakeven to net wins.

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