Using equity curve analysis to improve Forex strategy performance ...

If you look at the performance of a strategy over time it will usually show peaks and troughs in the equity curve, just like a chart of a share price or any other security. Take the chart below showing the equity curve for a simple moving average cross strategy, in which a buy order is given when the 50 moving average crosses above the 200 and a sell when it crosses back below the 200 on a 15min chart of eurodollar.

Currently the equity curve lies in negative territory and seems to indicate that the strategy is unprofitable, however, an analysis of the same chart using classical technical analysis tools yields a possibly different interpretation of how it might perform in the future. The picture below shows the same chart with some technical annotations added on:

In the figure above we can see the equity curve with a trend-channel drawn on and price patterns circled. In fact it appears that the equity curve adheres to similar laws that govern the price movements of other financial assets, for example, moving in trends and showing? patterning. This indicates it could be possible to analyse strategy equity curves in the same way as normal share charts and currency pair charts are interpreted.

To continue with our analysis therefore, on the chart above there is evidence we have reached an important low given the recent touch with the lower trend-line and the outline of a possible inverted H&S which is currently developing its right shoulder.

The current possible inverted H&S has a neckline at roughly -$8765.00. If this is broken it could usher in a new phase of improved performance for the strategy with a possible initial target lying just below zero at about trade number 850. Based on this analysis now could be a good time to begin trading this strategy, with a possible likely run up of over $8000.00 on the horizon.

The possibility that equity curves can be analysed using the same techniques as market technicians use to analyse financial markets is an interesting idea and one I believe worth perusing, although it requires specialist charting software, or the use of an excel add-on for the purposes of analysing the raw data using chart indicators.

It would be particularly interesting to use a clear-cut method for switching a strategy on and off, such as a point and figure chart format with its particularly crystal clear signals. Indeed it should be possible to adapt an equity curve to a point and figure format simply using graph paper by hand.

In this way it would be possible to optimise the strategy not simply from a mechanical indicator-led perspective as is currently emphasized but also by the analysis of a simple strategy?s equity curve using an objective on-off switch to optimise profitability. This gives trading system designers a two-pronged attack to enhancing the profitability of their trading systems, as well as another level of information on which to base trading strategy decision-making.

Source: http://blog.forex4you.com/using-equity-curve-analysis-to-improve-forex-strategy-performance/

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