Equity Curve Simulations

Revealing the truth

Positive Expectancy

Let’s talk about your trading edge.

Look at this graph.

  • The y-axis is the equity or account balance, starting at 10k
  • X-axis is the number of trades
 

It’s a simple equity curve simulation (thanks to due diligence hub for the tool).

The parameters I’ve used are

  • Starting equity of 10k
  • 50% win rate
  • 2:1 RvR
  • 1% risk per trade
  • £10k starting equity

This is a reasonable edge. You’re losing half the time, but when you DO win, you make twice as much as when you lose.

But just look at the results.

They vary massively.

In one simulation, after 50 trades (let’s say a month of active trading) you’re up a measly £118.

In another, you’re up over £4k!

Same metrics, but it’s just how the trades come during that relatively small sample size.

(I assume this chart uses compounding, ie the 1% risk is adjusted each time for pot size)

Luck plays a huge role in the short-term outcome.

Imagine that was your equity curve for a moment.

You might start thinking you are the next Paul Tudor Jones or throw everything away purely down to the randomness of results.

But if you just stuck it out – over time the numbers work out in the wash and you’d be profitable.

Alright let’s flip it on its head, let’s take a look at a simulation involving NO edge.

50% win rate and a 1:1 RvR

 
Sure, the average (black line) is about what you’d expect, but look at some of the outliers.

You could be fooled into thinking you have a positive expectancy when it was sheer luck!

And this ladies and gentlemen is why trading is so hard…

We haven’t even taken into account the psychology of scaling, being in drawdown, having a run of losers, commissions, spreads, and mistakes. Etc etc.

This is why we MUST make sure our edge is as robust as it can be.

Our win rate high and our RvR is strong.

No substandard trades creeping in. Just solid positive expectancy plays.

Today, think about your strategy. Do you believe that you have a strategy with positive expectancy?

That’s tough to define in your developing years I know.

The market is always changing its rhythm and flow. What works today might not work tomorrow.

But I believe strategies built around simple concepts have positive EV.

Exhaustion plays, momentum pauses, etc.

(I also believe that’s why you should push as hard as possible when you discover a big edge, because it might be shortlived).

Equity Simulator

Have a play around with the simulator yourself here.

Try different parameters and see just how much a small change affects the potential results.